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Keep the tax cut

By W. James Antle III
web posted June 10, 2002

Last week marked the one-year anniversary of the tax cut President Bush signed into law. Contrary to what you will hear from its liberal detractors - and some of its conservative boosters - this was a tiny tax cut compared to anticipated federal revenues or the overall economy. But it marked the first reduction in personal income tax rates in several years and restored billions of dollars to their rightful owners, the American taxpayers.

Tax reformer Grover Norquist cited estimates that the tax cut will help create 800,000 new jobs this year. By lowering marginal rates, however slightly, the tax cut increased the after-tax return on productive economic activity. Yet all this may be undone in 2011 because of the temporary nature of this tax cut. When it expires, marginal income tax rates will return to Clinton-era levels.

Suggesting that the Bush tax cut should be made permanent flies in the face of conventional wisdom. After all, ever since the reemergence of the federal budget deficit and last year's lackluster economic performance it has been fashionable to argue that the tax cut failed and should be abandoned. Leading Democrats have criticized it and a few have gone so far as to call for delaying large portions of it or even repealing it entirely.

Much of this criticism has not been supported by the facts. For example, tax-rate cuts were unfavorably compared to tax-rate increases because on the grounds that the former actually undermine economic growth prospects by increasing long-term interest rates. The policies Democrats credit with the 1990s expansion are said to have relied on tax increases to keep the budget in balance and lower long-term interest rates.

All of this takes for granted that the current size and scope of the federal government should not be reduced or that prosperity is necessarily insured by keeping interest rates low. Some of us would say that cutting government is a good thing in itself; others, such as those influenced by the Austrian school of economics, might question whether artificially low interest rates might in fact distort the economy by promoting bad investments not supported by the pool of funds. In any event, the high taxes/low long-term interest rates formulation can be empirically rejected.

In August 1993, when the previous administration's tax-rate increase was enacted, the interest rate on ten-year bonds was 5.68 percent. The interest rate on ten-year bonds was up to 7.96 percent in November 1994 and by the time it started falling, a lot of people had been elected to Congress on a platform that called for lower taxes rather than tax hikes. Similarly, the rate on ten-year bonds fell from 6.66 percent in January 2000, before the tax cut and during the budget surplus, to 4.57 percent in September 2001, after the tax cut and the deficit. The rate on 30-year mortgages dropped below 6.5 percent after both the tax cut and the deficit, after exceeding 8 percent in 2000 before the tax cut and during a record surplus. This 8 percent mortgage rate during the surplus was an increase from 7.3 percent in 1993, when the U.S. budget deficit equaled 4.3 percent of GDP.

While it may be premature to assign credit to the tax cut for some improved economic indicators last quarter, the objection that lower taxes would somehow hurt the economy can be safely laid aside. So too can repeated assertions that the tax cut unfairly benefited the "ultra-rich" after a decade in which the personal income tax rate structure was carefully crafted to make any tax cut that will benefit working people who pay a lot of taxes vulnerable to such charges.

If the tax cut is allowed to expire, taxes will effectively be raised in 2011. We will see a resurgence of the dreadful marriage penalty, an increase in the bottom marginal income tax rate from 10 percent to 15 percent and the child tax credit will be cut in half. The top marginal income tax rate will climb back up to nearly 40 percent and retirement contributions to IRAs will shrink more than 60 percent in inflation-adjusted dollars. It strains credulity to maintain that any of this will benefit the economy.

While the Republican-controlled House of Representatives has passed legislation making the tax cut permanent, such action has been blocked in the Senate. Senate Majority Leader Thomas Daschle (D-SD) refuses to allow a bill to this effect filed by Sen. Phil Gramm (R-Tex.) and Sen. Zell Miller (D-GA) to come to a vote.

Lower taxes have a proven track record of generating prosperity. This does not mean that last year's tax cut was perfect. A much larger and faster tax cut would be desirable both from the perspective of economic growth and liberty. A flat tax would yield much more impressive growth rates. Ending direct taxation entirely would re-limit the federal government and restore the U.S. Constitution. But even a small tax cut is better than no tax cut at all.

Conventional wisdom notwithstanding, our economy and republic could stand to benefit from lower taxes still. Letting last year's tax cut expire would be a step in the wrong direction.

W. James Antle III is a senior writer for Enter Stage Right.

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