Last week, both Houses of Congress passed the President's $330 billion tax cut. You know, the one that will supposedly bankrupt the country, screw the poor, and cause chaos to reign. Perhaps you've heard of it? It shouldn't be too surprising that these concerns are way, way overblown. After all, it's just a cut of taxes on capital. It'll increase investment, the economy's weak spot for the past three years or so, increase economic growth, and actually help the poor and the budget at the same time.
After the stock market bubble popped in March of 2000, business confidence and investment plummeted. Businesses had over-invested during the 1990's boom, and were left with tremendous amounts of excess capacity and few attractive investment options. Continuing geopolitical instability and corporate scandals have further harmed business confidence. This lack of confidence in the future has made businesses reluctant to invest. The Federal Reserve has tried to make investment more attractive by reducing interest rates to 50-year lows, but investment has yet to revive. So after three years of declining business investment, someone in the Bush Administration was brave enough to admit that America had an investment problem.
That's where the tax cut comes in. It is well known that the more something is taxed, the less of it there is. It's kind of an obvious principle. If a Big Mac cost eight dollars, you wouldn't buy it (well, you probably wouldn't buy it at the current price either, but that's a different story). Thus, current taxes on dividends and capital gains discourage the investing activities that produce dividend and capital gains income. By cutting these tax rates, it follows that investment would be encouraged. Again, not too shocking -- if investment is cheaper, people will do it more. Thus, the policy directly addresses what ails the economy, and is probably the best way to increase investment.
Of course, as with any tax cut, there are a whole bunch of people who see the need to complain. These complaints fall into three categories: "the tax cut will bankrupt the country" group, "the tax cut doesn't increase consumption" group, and "the tax cut screws the poor" group. While each of these criticisms contains a kernel of truth, they are by and large invalid.
By far the least valid criticism of the tax cut is that it is fiscally irresponsible and will bankrupt the country. In the first year, it will cost at most $100 billion, and will cost less in future years. I think we can afford to spend one percent of our GDP to help it grow at a rate of three and a half percent instead of the current rate of two percent. You don't have to be in Wharton to know that's a pretty good deal.
But what about the 2001 tax cuts, you say? Didn't they drag us into deficit? I doubt it, and so do most economists. Let's think about this: if the economy does poorly, federal revenues will go down, even if there is no tax cut. Furthermore, if we're fighting a war, spending will go up. That's what's happening now, but it sure isn't permanent. If we want to reduce the deficit, we can either stop fighting the war on terrorism or make the economy grow faster. Call me a hawk if you will, but I'd prefer to focus on economic growth.
This brings up another criticism: that the tax cuts will not provide short-term stimulus by increasing consumption. Most critics in this group are in favor of increased government expenditures on the poor. They argue that consumption, not investment, should be the focus of fiscal policy. So the question becomes: does consumption need to be stimulated further? The answer is a resounding no. Personal consumption expenditures have risen fairly quickly during the recession. In fact, not only has consumption increased, but so has savings. Consumer debt has also decreased. All of this has happened in a weak labor market with weak income growth.
Where are consumers getting the money to pull this off? The answer is: the 2001 tax cut. This tax cut will continue to help consumption, meaning that it's time to focus on investment: the economy's real weakness.
Here's where the "tax cuts screw the poor" group chimes in. Investment is something only rich people do, right? Don't tax cuts on investment only help them? Although it is true that direct benefits of the tax cut flow overwhelmingly to the rich, the indirect benefits, little things like jobs and growth, help all Americans, especially the average man and woman.
