Oh yeah Lumpy:
Here’s one for your wisdom concerning tax cuts (which, by the way, will only need to be “paid for” to the extent the government spends more money than it takes in – given your concern with the state of spending, I can’ imagine you would blame tax cuts for deficits…):
The Wall Street Journal
Tax Cut Lessons
April 30, 2004; Page A14
The first quarter economic growth figure rolled in yesterday at a 4.2% annual rate, with some on Wall Street professing disappointment that it didn’t meet their higher forecast. Well, some people are never happy, and the past year’s growth of 4.9% is the fastest since 1984, faster even than during the 1990s’ “boom.” Initial weekly jobless claims also fell yesterday, another sign that the employment market is continuing the comeback we first saw in March.
In short, we’re arriving at the point where we can say the economy is on the path of robust, self-sustaining expansion. We are also at the point where we can begin drawing some policy conclusions from the economic debates of recent years.
To wit, the Bush tax cuts have worked. Perhaps not as rapidly as everyone hoped, for reasons we will explain below. But as the nearby chart shows, the recession that began shortly after President Bush took office was relatively brief and is now finally fading into unblessed memory.
One important policy lesson is that both the kind and pace of tax cuts matter a great deal. Recall that in order to get his first round of tax cuts through the Senate in 2001, Mr. Bush accepted New Jersey Democrat Jon Corzine’s proposal to put money in consumers’ hands more quickly – in short, the tax “rebate.” The theory was that poor and middle-class people spend money, while rich folks save it, so cut taxes for them but not for the rich.
He and his fellow Democrats resisted Mr. Bush’s plan to cut marginal income tax rates and demanded that those cuts be phased in over five years. So in the case of the 2001 tax cuts, only small reductions were immediately implemented, with the rest coming in 2002, 2004 and 2006.
We now know that the “stimulus” from those tax rebates was indeed ephemeral. They gave a short-term lift to demand, as Keynesian theory posits, but once the money was spent, the impact faded. Take another look at that nearby GDP chart.
Meanwhile, a new paper from the National Bureau of Economic Research confirms that the initial reaction to the phased-in marginal rate cuts of 2001 was also muted, or may even have been negative over the short term. Some of us worried about this at the time, because we remembered that the Reagan recovery that took off in 1983 was delayed for two years after his marginal rate cuts were also phased in.
The new study by economists Christopher House and Matthew Shapiro shows that the most powerful effect of tax cuts is their ability to change future behavior on the supply side. That’s because workers and firms respond rationally to incentives, and they produce more when they are allowed to keep more of the gains. But when tax cuts are deferred, investors and businesses naturally postpone some of their economic activity until a later date when tax rates will be lower.
The second round of Bush tax cuts were by contrast effective immediately. The 2003 cut accelerated the marginal rate cuts first passed in 2001, and the additional cuts in dividend rates (to 15% from regular income rates) provided another incentive boost. Only since this tax cut passed – over the heated resistance of Mr. Corzine and his former Goldman Sachs partner Robert Rubin – has the economy begun to gain genuine momentum. Had Mr. Bush ignored their advice earlier, the expansion might well have accelerated sooner.
We recognize that other things have contributed to the recovery, notably an accommodative (currently too much so) Federal Reserve policy. The ebbing of the corporate scandals and business adjustment to terrorism risk have also helped to restore animal spirits.
But you can certainly bet that if the economy were weak, liberals would be giving tax cuts the blame, as some of them still do contrary to all available evidence. As for Republicans, it’s about time they stopped being so defensive over charges of “tax cuts for rich” and started pointing out that their policies are once again giving everyone a chance to get rich.