Unfinished Business
The Democratic primaries are shaping the policy debate surrounding the upcoming presidential election. When it comes to tax policy, all the candidates seemed unified in their determination to repeal some, if not all, of President Bush’s tax cuts. These efforts to take resources away from taxpayers in favor of a larger federal budget are often grounded in class warfare or concerns over deficit spending. However, before abandoning the tax cuts, it may be wise to review the current state of the economy. Recent economic trends suggest that Bush was right to cut taxes; in fact, economic growth could be bolstered by making these cuts permanent.
In the second half of 2004, the economic recovery was in full swing. Business investment increased along with productivity. Third quarter economic growth registered at 8.2 percent, a rate not seen in 20 years. The values of U.S. stocks increased by $2 trillion over the year, and personal income increased by 5.8 percent. Unemployment trended downward, falling from a high of 6.3 percent to 5.7 percent. While much has been made of the jobless recovery, John Lott of the American Enterprise Institute notes, much of this debate may result from differences between the statistical sources used to determine the unemployment rate. While employment figures could be improved by stronger economic growth, Lott goes on to note, “Given this rhetoric, it hard to believe that the current 5.7 percent unemployment rate is lower than the average unemployment rates during the 1970s (6.4 percent), 1980s (7.3 percent) or 1990s (5.8 percent).”
In response to Democratic calls for rolling back the tax cuts, President Bush has announced his intention to make the tax cuts permanent. Bush understands the importance of tax cuts and the need to move forward, not backward, on tax reform: “In my budget for the upcoming year, I will ask Congress to make permanent all the tax relief we have delivered to the American people and our nation’s small businesses. If Congress fails to act, the tax relief will disappear and millions of American families and small businesses would see tax hikes starting in 2005.”
Undoubtedly, whoever wins the presidency, tax policy will be one of the first issues addressed in Washington. Because Congress rejected permanent tax cuts, the threat of higher taxes will bring the issue to the fore. If Bush wins, the starting point will be taking the existing tax cuts as a given and moving to make them permanent. If a Democrat wins, the starting point is not so taxpayer friendly– ”the tax cuts were not permanent, and it is time to review them to determine which cuts are “fair” and which can be repealed as “tax cuts for the rich.” Tax policy would be up for grabs.
In either case, the battle will be fierce in Congress, where spending has been rising at unprecedented rates. Even if Bush wins, there is no guarantee that his proposal to make the tax cuts permanent will be rubber-stamped by Congress. Concerned about spending priorities and burgeoning entitlement programs, Congress may be less than enthusiastic about reducing its stream of revenues. While a prudent approach would entail fiscal discipline that includes spending control and entitlement reform, a more expedient approach may find Congress passing another “temporary” tax cut instead of making the current tax cuts permanent.
Unfortunately, another incentive to pass a “temporary” tax cut is that tax policy can be a lucrative business. Short-term policies force lobbyists and other special interests to return to Congress on a regular basis in order to protect or expand their gains under the tax code. While such uncertainty may do well to fill campaign coffers, it wreaks havoc on businesses trying to plan for the future. Certainty, or permanence, allows business to make investments that expand output and generate jobs. Which is why Bush’s call to make the tax cut permanent will not only lock in the benefits of the previous tax cuts, it will also provide stronger incentives for capital investment and economic growth. Clearly, the coming year will provide an important opportunity to debate the direction of economic policy in the United States. At this point a clear line has emerged between President Bush and his Democratic rivals.
The president wants to build on the strengths of the current economic recovery, locking in the benefits of the tax cuts by making them permanent. Democrats, on the other hand, continue to see tax policy as a tool for social engineering, with policies aimed bolstering federal revenues while providing targeted tax cuts for specific groups. A better plan would be to make the recent tax cuts permanent while cutting wasteful spending and reforming regulatory constraints that stifle economic activity. Fiscal prudence, coupled with better incentives to work, save, and invest, would do far more to bolster the economy.
