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President Bush’s tax cuts and the Democrats’ economic illiteracy
Gerard Jackson
The Democrats’ continued carping, encouraged by their media mates, about President Bush’s tax cuts suggests a genuine inability to understand the damage that high tax rates cause. That Bush played politics with tax cuts is indisputable. He would be very stupid if he did not. Anyway, not only is the charge pretty silly coming from Democrats and the media it also misses the point. What matters is whether the 2003 tax cuts worked or not. They did.
Because of the extent to which investment and jobs fell after 9/11 some argued that the economy needed a massive cash injection to stimulate consumer demand. But any fiscal policy that promotes consumption only undermines investment and prolongs recession. The 2001 Keynesian tax cuts focussed on consumer rebates, which were only one-offs, and credits for couples with children.
There was virtually nothing in the cuts to encourage greater investment. The result was a sluggish economy*. We now know that consumer spending did not even falter during the recession, thereby demonstrating that the recession was not the result of falling consumption. Fortunately there were those who saw the problem in terms of investment rather than demand deficiency.
(It should be borne in mind that tax cuts that are not underwritten by a monetary expansion not only change the composition of demand they do so in a way that ultimately raises real — as a opposed to monetary — demand through increased investment).
What should have alerted economic commentators were figures showing that spending in the manufacturing sector had been falling along with employment for some time. And this is where the recession first struck, even though GDP was still rising along with the total demand for labour. The contraction in manufacturing should have made it apparent to economists that though stimulating consumption might have kept recession at bay for a while it could have done so only by aggravating conditions in the manufacturing sector. Fortunately there were those who realised that only genuine investment, not consumption, raises real incomes and output. This is where cuts in capital gains taxes come in
Some economists still query the argument that eliminating the tax on dividends stimulated investment. What these critics miss is that abolishing taxes on stocks reducing the cost of investing and so makes saving more attractive which in turn encourages more investment. Abolition would also free up more money for alternative investments by discouraging companies from using retained earnings for excessive investment in their own concerns. In other words, if you want more of something — in this case investment — then you must lower the cost of producing it. The reverse is equally true.
Let us focus for a moment on the capital gains tax. Where this levied on the sale of assets, e.g., shares, it has the effect of reducing the number of transactions because that is one of the ways of avoiding the tax. In short, capital gains taxes are also transaction taxes where they are levied on realised gains. Imagine for a moment what would have happened to economic growth in nineteenth century England if, for instance, investors had been punitively taxed for trying to invest in railways instead of keeping their savings in canals or government bonds?
Therefore capital gains taxes trap savings in established companies by erecting a barrier to the movement of savings to newer and more innovative enterprises. In fact, they become a tax on social mobility, as does a highly progressive income tax structure. It protects those who can live off their family’s accumulated capital against those who are trying to accumulate capital: it is not a tax on the rich but on getting rich; it encourages those who have accumulated wealth to simply conserve it while reducing the flow of savings.
Filthy rich Democrats like Pelosi, Kerry and Kennedy need to explain why tax cuts that promote capital formation and raise real wages and living standards manage to benefit only the rich. They need to explain why they adamantly oppose tax policies that would not only encourage small investors to save more but also encourage millions more to join their ranks and expand the nation’s investment pool. Perhaps this is what they fear: a large mass of small independent-minded investors.
* Prices and Production, Augustus M. Kelley 1967 and The Paradox of Saving, in Profits, Interest and Investment, Augustus M. Kelley Publishers, 1975.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 11 December 2006