Supply-Side Stimulus Can Spur Recovery

As printed in the September 27, 2001 edition of the Wall Street Journal

Even before the tragic events of Sept. 11, the economy was struggling. Many economists feared we were headed for an economic downturn in spite of aggressive interest-rate cuts by the Federal Reserve and tax rebates designed to put money in people’s pockets as quickly as possible. While, in our opinion, the economy needed help beyond these measures, neither Congress nor the White House could do more because of past promises to keep their hands off the Social Security surplus.

Likewise, the Fed had imprisoned itself inside the self-imposed procedural box of targeting interest rates. As a result, monetary policy remained too “tight” even as interest rates were falling, which meant a combination of tight fiscal and monetary policies were working in tandem against our hopes for an economic revival.

Now, in the aftermath of this despicable act of war, our economy and the world economy have come under incredible stress, and we cannot afford to stand idly by arguing about who lost the budget surplus and simply targeting interest rates while people lose their jobs, loans go bad, asset values collapse and businesses fail. Success in war, as in peace, depends upon a strong, growing and vibrant economy.

To its credit, the Fed initially responded to the crisis by jettisoning interest-rate targeting temporarily, and for a short while allowed the fed funds rate to trade below its specified target. Three cheers for Alan Greenspan.

In the past few days, unfortunately, the Fed appears to have reverted to the previous Federal Open Market Committee policy. We think that’s a mistake. In our opinion, the Fed should follow a new monetary rule, i.e., some kind of price-level targeting, as suggested by former Fed governor Wayne Angell. This would allow the Fed to inject substantial liquidity into the market to meet rising demand. The Fed must assure markets that liquidity won’t dry up, especially if tax rates are cut.

It is also time for Congress and the White House to put aside their effort to lock up the Social Security surplus. Clearly we must spend new monies to help the victims, rebuild the infrastructure, increase airline security and carry out a war against terrorism. We must also avoid using the emergency to go on a spending spree and make sure the new spending is well conceived, prudent and effective.

Likewise, the events of Sept. 11 must not be used as an excuse for just another tax cut to put more dollars in people’s pockets. That won’t work. Instead, we need the right kind of tax rate reductions to revive the productive and entrepreneurial sectors of the economy, which will raise more revenue in the long run by reviving economic growth. We believe that any tax bill must contain three core components to revive economic growth:

First, the capital gains tax rate should be cut substantially to increase the rate of return on capital investment. The Gramm-Miller capital gains tax cut bill now pending in the Senate — a measure that would cut the top rate from 20% to 15%, and the 10% rate to 7.5% — would be a good start.

Some people have expressed concern that cutting the capital gains tax would produce a sell-off in stocks. We don’t think that would happen because cutting the capital gains tax raises the long-run value of any company’s stock. People should not forget the capital gains tax is a voluntary tax, and when the rate is too high people keep their capital gains locked in. It is demagoguery to suggest, as some do, that cutting the tax on capital investment is a “give-away” to the “rich.” The capital gains tax is not a tax on the rich; it is a tax on the American dream.

Second, the tax rate reductions enacted into law earlier this year and scheduled to phase into effect slowly over the next five years should be made effectively immediately. The economy needs lower rates today not because they put money in people’s pockets, but because they increase the reward for work, saving, and investment: Exactly what we need right now.

Third, depreciation of investment in plant, equipment and technology should be accelerated and reformed along the lines of the bipartisan High-Productivity Investment Act. Until businesses can write off the full amounts of both their capital and labor expenses, the economy will underperform and the government will be deprived of the full measure of revenue it needs to spend on vital activities in wartime.

Beyond these three core components, we believe there is another idea Congress and the White House should take under advisement. There is considerable interest in giving workers a credit against their Social Security payroll taxes to ensure that a tax cut goes to even those people who do not pay income taxes. If a bipartisan consensus develops around this idea, we believe it must be done in a way that strengthens the supply side of the economy and helps meet the needs of the current crisis.

Therefore, we suggest giving workers a credit against their payroll taxes in the form of a Freedom Bond, which would be identical in every respect to the regular 30-year bond issued by the federal government. The only proviso would be that the Freedom Bonds or proceeds from selling them be held in a 401(k) or individual retirement account.

The virtue of this idea is that it allows the enormous spending requirements necessitated by the terrorism war to be met out of federal borrowing in a way that also strengthens workers’ long-term retirement. By lending the government their payroll-tax credit and receiving Freedom Bonds in exchange, every American worker would help finance military and rebuilding efforts. Workers literally would be investing in their retirement by investing in the future of this great country, the highest form of patriotism.

Mr. Kemp is a co-director of Empower America and a former Republican congressman from New York. Mr. Miller is a Democratic senator from Georgia.