The Tax Cut Record
Americans are better off despite Democratic naysaying.
Sunday, May 14, 2006 12:01 a.m. EDT
Our late editor Bob Bartley used to say that critics might forgive you for being wrong, but they'll never forgive you for being right. That psychological insight may be the only way to explain the fierce and bitter opposition this week to extending the tax cuts of 2003 for another two years through 2010.
If ever there was a market test of economic policy, the last three years have been it. The stock market has recovered from its implosion in Bill Clinton's last year in office, unemployment is down to 4.7%, and growth has averaged 3.9% in the three years since those tax cuts passed--well above the post-World War II average and more than twice the growth rate in Euroland.
Yes, gas prices are high and interest rates are rising, which helps to explain the anxiety felt by some of the public. But these headwinds are all the more reason to be impressed by the economy's ability to push ahead nonetheless. We'd have thought that the Democrats who are now voting to let taxes increase would be thrilled to know that things turned out better than they had feared. Americans are better off despite Democratic predictions that, as Minority Leader Nancy Pelosi put it back in 2003, tax cuts would "damage long-term economic growth."
Alas, admitting error is not a natural political act, so the tax cut critics are now suggesting all of this growth would have happened anyway. Thus the Washington Post last week quoted Robert Rubin--the Clinton economic guru--as dismissing the importance of tax cuts because "we had very good markets in the '90s before all these tax cuts went into effect." And it quoted chief Lehman Brothers economist Ethan Harris as saying that the expansion "has nothing to do with tax policy, and more to do with the corporate sector starting to spend some of their record profits."
Well, what does Mr. Harris think inspired that revival of business spending? Spontaneous combustion? A Nascar green flag? As for Mr. Rubin, when does he think the stock market imploded and the economy headed downhill? Bill Clinton was still in office when the dot-com boom went bust and U.S. manufacturing was shedding jobs faster than France.
What these gentlemen want everyone to forget is the unique nature of the 2001-03 recession and sluggish revival. After the stock-market collapse, 9/11 and Sarbanes-Oxley, American business was shell-shocked. Hiring at the Fortune 500 was nil and corporations were hoarding cash. The 2001 one-time tax "rebate"--pushed as the economic cure by Mr. Rubin's former partner Jon Corzine in the Senate--and phased-in income tax cuts had provided only a short-term lift. Only consumer spending, buoyed by easy Federal Reserve policy and a housing boom, prevented a deeper recession.
But everyone understood that the Fed couldn't stay easy forever, and some of us started saying three years ago that it already should be tightening. (Inflation is our biggest current worry.) The 2003 tax cuts on dividends and capital gains were designed precisely to help business supplant consumer spending as the engine of recovery. By boosting the after-tax return on capital and increasing incentives to invest, the tax cuts provided an immediate lift to stock-market valuations and improved business balance sheets.
Almost at the very time the tax cuts looked like they would pass, business investment began to pick up, and it has kept rising since. As the nearby chart from a new study by the Joint Economic Committee of Congress shows, this has been a classic investment-led expansion with record amounts of business spending on new plant, equipment, machinery, software, and research and development.
Between May 2003 and May 2006, asset values in the U.S. have also risen by $13 trillion thanks to the stock and housing market rallies. Just the growth in asset values since 2003 exceeds the entire net worth of all but a handful of nations. Democrats who want the 15% rate on dividends and capital gains to go back up to 39.6% and 20% are saying that a big tax increase won't affect any of this.
As for whether the tax cuts favor "the rich," this deserves longer treatment on another day. For now, suffice it to say that one reason tax revenues are rushing into the Treasury at a record pace is because the rich are paying them. The tax payments of the wealthiest 3% of Americans increased at twice the rate of the tax payments by everyone else from 2001-2004. And those richest 3% now pay nearly as much income taxes as the other 97% combined. While the incomes of the rich have risen, the lower 2003 tax rates are still soaking them for the government's benefit.
Over the past 40 years, the U.S. has had three great experiments in tax-cutting, and each one has worked even better than advertised: The Kennedy tax cuts of the 1960s, the Reagan cuts of 1981, and now the Bush tax cuts of 2003. The political tragedy is that the first of those two were bipartisan, while the Bush tax cuts have had little Democratic support. Only 15 House Democrats supported their extension this week; there were only three in the Senate.
Perhaps they should recall the words of a famous Democrat from another era: "The tax on capital gains directly affects investment decisions, the mobility and flow of risk capital . . . the ease or difficulty experienced by new ventures in obtaining capital, and thereby the strength and potential for growth in the economy." That was John F. Kennedy, and he's still right today.
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