President Bush's tax cut has the potential to substantiallyincrease economic growth, boost the stock market, and increasebusiness investment. The jewel of the President's tax plan is theelimination of the dividend tax on individuals. Another keyeconomic growth provision of the tax plan is the acceleration ofincome tax rate reductions. My estimates are that the tax plan, iffully implemented, would increase stock values immediately by 5% to15% and would reduce the cost of capital for businesses by 10% -30%, depending on the industry.
Contrary to concerns that the Bush tax cut is "too big and toobold," I believe that the President's plan would be even morestimulative for economic growth if it were expanded to includeseveral provisions. First, Congress should cut and consolidateincome tax rates more than in the President's plan. The income taxrate should be consolidated down to 3 tax rates: 10%, 20%, and 30%.Second, tax free IRA savings accounts should be vastly expanded, inmuch the same manner as the White House has suggested. Super saverIRA accounts should be established with a cap of $20,000 per yearper individual. The money in these funds should not be taxed untilit is withdrawn for consumption purposes. Third, the capital gainstax should be lowered to 10% on all new investment.
The President's tax plan has many strengths, but one overridingvirtue is this: it moves the federal tax system inexorably toward asingle flat rate consumption tax system. Eliminating the double taxon dividends, abolishing the death tax, lowering income tax rates,and expanding tax free savings accounts are all big steps towardthe promised land of a flat rate tax system that ends doubledtaxation of saving and investment-the building blocks of a rapidlygrowing economy. Whatever modifications or additions to the Bushtax cut that Congress enacts should be consistent with theprinciples of a tax system that taxes all income at the same rate,once, and only once.
Myths About the President's Tax Plan
1. The Bush tax cut "benefits only the rich."
The media continues to report, as The New York Times has, that"90% of Americans…will get little or nothing from thedividend tax cut." Wrong. The Tax Foundation's recent examinationof IRS tax return data finds just the opposite. Fully 34 millionAmerican tax filers reported some dividend income in 2000 and thesereturns represent 71 million people. That is a whole lot more than10% of the population who will directly benefit.
The income tax cuts are even more widely distributed. Anyone whopays income taxes and dreads the coming of April 15th will get anincome tax cut under the Bush plan. The typical working family with2 incomes and an income of $60,000and I suspect very few of thesehouseholds regard themselves as "rich"would get a $1,200 a year taxcut from the Bush plan. If the income is $40,000 the family gets a$600 tax cut and not just for one year, as under the Democraticalternative plan, but forever.
Proportionately, the rich get a smaller share of the Bush taxcut pie, not a bigger slice than the middle class. For example, theTreasury Department reports that for Americans who make more than$100,000 a year, the share of all federal income taxes paid wouldrise from 72% to 73%. For those who make less than a six-figureincome a year, their overall share of the tax load goes down.
2. The Bush tax cut will blow a hole in the deficit.
The Bush tax cut provides $670 billion in tax relief forAmericans over the next 10 years. This will hardly bankrupt thefederal treasury. Over the next ten years the IRS will collect some$25 trillion in taxes from Americans. So the tax cut comes to lessthan 3 cents on the dollar, hardly a massive giveaway.
Nor is it accurate to say that the national debt will rise bythe amount of the tax cut, unless one believes that tax cuts resultin absolutely zero change in economic behavior. The truth is thatfor every action in the economy, as in physics, there is areaction. If we cut income tax rates and eliminate the double taxon dividends, surely workers, and businesses, and investors willbehave differently. If the tax on work and hiring goes down, surelywe will get more of both. If the tax on investment goes down andthe after-tax rate of return goes up, surely we will get more ofthat too. If the tax on dividends is eliminated and the capitalgains tax falls as well, surely we will get more businessinvestment and higher stock values.
Opponents of the tax cut continue to tout the results ofeconomic models that have a perfect batting record of being wrongin predicting the future. For example, in 1997, when the capitalgains tax rate was cut from 28% to 20%, the crystal ball gazersinside and outside government predicted a multi-billion dollar"cost" to the Treasury. In fact, the capital gains receipts doubledin 4 years. These are precisely the same defective models that arenow telling us the Bush tax cut will lead the nation intobankruptcy.
Bill Beach, the economist and forecaster at the HeritageFoundation, reports that the dividend tax cut alone is such potentmedication for the economy that the Treasury Department shouldrecapture about 50 to 70% of the supposed tax revenue loss from thetax cut. Beach finds that the real world cost to the government ofthe Bush tax cut is probably at most half the reported "cost." I'dput my money on Beach's estimates, which have a far more accuratetrack record of accuracy.
But let us assume the worst-case scenario: no economic responsefrom the Bush tax cut whatsoever. We could still have the Bush taxcuts and a balanced budget. If Congress were to modestly controlits appetite for new spending, the tax plan could be implementedfully and the budget returned to balance by 2006. In a study forthe Cato Institute I found that if overall federal spending wererestrained to 2% annual growth over the next four years (whichshouldn't be too difficult in this era of almost no inflation), thefederal government would start running surpluses by 2006 even if weassume that the Bush tax cut incited no economic feedback and weinclude the costs of the war. If the tax cuts do generate growth,the budget would be balanced by 2006 or sooner.
Another reason to suspect that the Bush tax cut will not run upthe deficit is that if the taxes aren't cut, it is much more likelythat Congress will spend the money than save it. In other words,taxes cause spending, and the lack of taxes impose at least somespending discipline. Ohio University economist Richard Vedder hasdocumented this relationship between tax revenues and spending andhas found that each additional dollar of taxes available forCongress to spend leads to nearly a dollar of added spending. Nobelprize winner Milton Friedman notes that one of the strongestarguments for the Bush tax cut is that it will discourage astampede of congressional spending over the next several years.
3. The Bush tax cut won't stimulate economic growth or jobs.
All we can really rely upon to judge the economic value of taxrate reductions is the economic reaction to tax cuts in the past.Fortunately, Bush has history firmly on his side. The 1964 Kennedyincome tax rate reductions spurred a bull market expansion andbudgets in near balance through the 1960s. The 1981 Reagan tax cutsushered in 7 consecutive years of prosperity and 15 million newjobs. The 1997 capital gains cut corresponded with a bull marketrally in the stock market and a surge of investment spending andventure capital funding for new businesses.
The critics argue that the 2001 Bush tax cut has failed toprovide any juice for the economy. But there's a good reason forthat. Seventy percent of the tax cuts haven't taken effect yet. Allthe more compelling reason to speed up the tax cuts so they canprovide immediate economic aid. Especially critical is to chop thehighest and most economically punitive tax rates. Roughlytwo-of-every-three Americans who pay the top income tax rate arebusiness owners or sole proprietors. If you want jobs, you needfinancially healthy and confident employers with dollars toinvest.
The dividend tax cut will have the same salutary effect onlarger businesses. For example, John Rutledge, a respected WallStreet economist, has estimated that ending the double tax ondividends increases stock values by roughly 10% or an $800 billionincrease in wealth, reduces businesses cost of raising investmentcapital by 25%, and helps stimulate a recovery in the battered hightechnology and telecom industries most. Many stock analysts,including economist John Rutledge of Kudlow and Co., believe thatpassing the dividend tax exemption and the acceleration of incometax rate reductions could add another 5 - 10% or so to equityvalues. That's the equivalent of a $500 billion to $1 trillioninstant boost in wealth.
Clearly, even Americans who do own stocks that do not paydividends or who own stocks in tax free 401k plans or IRAs willbenefit from the dividend tax cut because of the increase in thevaluation of stocks.
The Case for Growing the Bush Tax Cut
To maximize the positive job and wealth-creating impact of theBush tax plan, it should not be shrunk, as some in the Housesuggest, it should be expanded to perhaps twice the size that theWhite House has recommended. I am pleased that Rep.s Paul Ryan ofWisconsin and Pat Toomey of Pennsylvania have teamed up to craftsuch a plan.
President Bush's plan will incentivize supply side growth byeliminating the dividend tax elimination and speeding up income taxrate cuts. But it omits tax policy changes that would improve thetax code, help the economy immediately, and cost the Treasurylittle or nothing in terms of lost revenues. This strategy wouldlift the tax drag that is still impeding growth and hasten theeconomy's recovery to the 4% to 5% real GDP growth that the UnitedStates is uniquely capable of achieving. It is worth reminding themembers of the Committee that even in the first year of the plan,the tax cut amounts to less than 1% of the entire GDP. The Reagantax cuts of 1981 and the John F. Kennedy tax cuts of 1964 wereabout 3 to 4 times larger in size than what President Bush hasproposed.
Growth is the key to balancing the budget. A balanced budgetwill require at least a 3% to 4% economic growth rate to generatethe revenues to pay for expected federal spending over the nextdecade. Every 1 percentage point increase in sustained economicgrowth generates an extra $1 trillion of tax receipts over tenyears. The best way to produce tax receipts is to put people backto work; to get the stock market growing again; and to returnAmerican businesses to robust profitability. Tax cuts aren't thenonly way to make higher growth achievable, but history repeatedlyshows they can sure help.
As such, here are the additions to the Bush tax plan that areworth consideration:
1) Consolidate the income tax rates down to three: 10, 20, and30. Getting the top tax rate down to 35% is good, but 30% would beeven better. For those who argue that this would lower the top taxrate too much, we would remind critics that in the late 1990sReagan got the top tax rate down to 28%. Lowering the top incometax rate back down to 30% would help attract trillions of dollarsof foreign investment capital back to the U.S. and would helpreverse the decline in the dollar. Also, because 2 of every 3taxpayers in the highest tax bracket today is a sole proprietor ofa small business, lower tax rates will mean more business expansionand more jobs.
2) Cut the capital gains tax to 10% on all new investment. Thelast capital gains tax cit in 1997 increased stock values,increased business investment and venture capital funding, andhelped spur a huge stock market rally. That has been the economicreaction to virtually every capital gains tax cut over the past 40years. The capital gains tax cut is the goose that lays the goldeneggs. Keep cutting until we eventually get down to zero.
3) Expand tax free IRAs and 401k super-saver accounts. This willhelp create larger individual pools of household savings and wealthaccumulation. The latest Fed report shows that 52% of householdsnow own stock and that this mass democratization of the U.S stockmarket has caused impressive increases in average household wealthin the U.S. - from $50,000 on average in the mid 1980s to almost$75,000 today (adjusted for inflation). IRAs and 401ks help buildfinancial self-sufficiency and less reliance on the governmentprograms. Moreover, we should stop double-taxing Americans'savings. IRAs and 401k's should be dramatically liberalized byraising limits by $5,000 per year. The goal should be to eventuallycreate unlimited supersaver IRAs, where any money that is saved outof income is not taxed, until the funds are taken out of thesavings account to be spent. The income limits for IRAs should berepealed too.
One last, but crucial point. Republicans need to adopt dynamic,real-world scoring of tax policy changes. Stop using a tax refereethat is biased against the President's program and thatconsistently produces discredited predictions of the future. For 30years economic models in Washington have over-estimate the revenuegains from tax hikes, and overstated the tax losses from tax ratecuts.
President Bush deserves great credit for proposing a tax planthat has the potential to increase economic growth and create jobs.The economy needs a jolt of tax cut adrenaline given the recentdiscouraging financial numbers that have been released. The factthat we are on the eve of war, is an argument for revving up oureconomic engine of industrial might, not hindering its productivecapacity with a dysfunctional tax system.