A Return to Fundamentals

This year’s State of the Union was delivered to an anxious audience, both at home and internationally. While the question of war was paramount for much of the audience, the present economic malaise was just as pressing for many viewers. To address these concerns, President Bush rightly called for a return to economic fundamentals. The president’s agenda focuses on strengthening economic growth and targets existing policies that limit growth and job creation: a punitive tax code, burdensome regulations, frivolous lawsuits, and costly federal programs that are unsustainable without major reforms.

As noted by the President, the economy is not in shambles. In fact, economic indicators suggest that a recovery is underway. Trouble spots remain, and progress may be slow, but the economy appears to be recovering from the shocks of September 11 and the high-tech bubble that preceded it. Productivity and output are increasing, income is making moderate gains and inflation is low. Employment is weak, but unemployment continues to hover at around 6 percent. http://www.whitehouse.gov/fsbr/esbr.html

In many ways, the fundamentals of the economy remain strong, so the president’s emphasis on growth rather than government spending to boost the economy is correct. Instead, President Bush chose to focus on impediments that keep entrepreneurs and investors from generating the jobs and growth that expand the economy. Barriers to work, investment, and innovation ultimately reduce economic output. Removing these barriers strengthens the economy and lays the foundation for a stronger economy today and in the future.

The U.S. tax code has become perhaps the most visible obstruction to a stronger economy, especially in a global marketplace with mobile capital. Unfortunately, the United States has one of the most complex tax codes of the industrialized world, and U.S. corporate tax rates are higher than those in most industrial nations. A complicated tax code and high rates is a recipe for capital flight, with money—and jobs—moving to friendlier environments. President Bush’s tax cuts are a sorely needed solution.

The proposed tax cuts not only strengthen businesses and their ability to create new jobs, they help all taxpayers as well. First and foremost, the president is calling for cuts in marginal tax rates that should be made permanent immediately. Congress has already passed a package that includes these cuts, but they are phased in over time and are ultimately scheduled to disappear unless Congress takes action to make them permanent. Congress cannot avoid addressing this issue at some point in time, and according to the president, there is no time like the present.

Such marginal rate cuts provide incentives for investors to invest more, for entrepreneurs to innovate more, and for workers to work more, all of which enhance economic growth. In addition, the president has called for reducing the marriage penalty, increasing the child tax credit, and moving forward with the creation of a lower 10 percent tax bracket—policies that ensure all taxpayers benefit from tax cuts. Finally, the president has also proposed eliminating the tax individuals pay on dividends—a form of double taxation that most other industrial nations have eliminated. All told, the president’s tax proposals are an important step toward fundamental tax reform and a simpler, fairer tax code.

Improving the tax code and reducing marginal tax rates are both critical for improved economic growth, but more is needed. More resources will be available to the private sector, but an excess of regulatory barriers limit opportunities to put these resources to work. The president included several proposals to address these problems, including a more market-based energy policy and the healthy forest initiative, which will improve forest management while protecting forests and communities from the threat of wildfires. These are important first steps, and the same principles should guide regulatory policy throughout the government. Regulations should not impose more costs on the nation than the benefits they provide, and where regulations are introduced, it must be ensured that they are implemented in the least costly manner.

Another important component of the president’s domestic policy proposals is an examination of the government’s own behavior. With the threat of war hanging in the air and a mounting deficit, government spending cannot be as freewheeling as it has been over the past decade. The president proposed a 4 percent increase in federal spending, staying in step with the increase in income that most families will see this year. This call for renewed fiscal discipline is welcome as is President Bush’s call for major reform of two of the largest federal programs, Social Security and Medicare. Both of these programs are veering toward insolvency, and without significant changes both will require higher taxes, reduced choices, or both. The president has offered reforms that put individuals in greater control of their future with personal retirement accounts for Social Security, and a Medicare system that provides greater choices for seniors seeking health care.

Finally, President Bush identified an emerging burden on the U.S. economy—the litigation explosion that is raising costs and reducing choices for consumers across the nation. While the third branch of government is rarely mentioned in the State of the Union, the judiciary is increasingly responsible for billions of dollars of costs in the economy. The direct costs of the legal system are roughly $180 billion annually, equivalent to a 2 percent tax on consumption. http://www.cse.org/informed/issues_template.php/1197.htm . State courts alone handle more than 15 million cases annually. Recently, the costs of the litigation crisis have become more visible, as many communities are losing doctors who can no longer afford medical malpractice insurance. Tort reform is an important issue that cannot be ignored by Congress.

President Bush has outlined an aggressive economic agenda to strengthen the economy and create new opportunities for all Americans. The plan is not a call for increased government spending or a government-orchestrated recovery; nor should it be. The private sector is the source of wealth creation, and the president has identified a plan to promote productive activities. The mix of tax reform, regulatory reform, legal reform, and fiscal discipline may be a daunting challenge to Congress. Yet with both houses of Congress controlled by the administration’s party, now is the perfect time to accept that challenge.