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How about a tax cut that investing America will feel?


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Larry Kudlow

As a remedy on the way for depressed investor spirits and sinking business confidence? It could be, in the form of a capital-gains tax cut.

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Republican congressional leaders Trent Lott and Dennis Hastert are proposing a reduction in the capital-gains tax rate to 15% from 20%. Even liberal Massachusetts Democrat John Kerry indicated that he supports such a cut, saying it “would help spur the kind of investment that is not taking place.”

Hold that thought Mr. Kerry. Your timing couldn’t have been better.

Following the Fed’s scorched-earth deflation of the stock market and the economy, business investment has totally collapsed. In the cutting-edge technology sector, order books have plunged more than 30% over the past year while share prices have dropped 60%. Overall, business-capital spending declined 15% at an annual rate in the just-reported April-June quarter. The domestic private-sector economy (GDP less government and trade) has declined in the past two quarters.

Business leaders agree that times are tough. New General Electric CEO Jeffrey R. Immelt told the Wall Street Journal “we’re seeing no improvement in the industrial technology sector.” GE is a global company with a diverse business portfolio that includes technology, manufacturing, financial services, and broadcasting. It’s a truly real-time indicator. A year ago, former GE chief Jack Welsh correctly predicted the onset of global deflation. Now, new CEO Immelt believes there are “no fundamental signs of it getting better.”

While the Fed has been lowering interest rates and expanding the money supply, we are learning once again that you can lead a horse to water but you can’t make it drink. In the aftershock of the stock market collapse — with its massive evisceration of capital — investors have turned completely risk averse, preferring to keep their new money in safe cash funds instead of putting it at risk in the economy. Americans are not even spending their tax-rebate checks, instead using the cash to pay down debt.

Also, the seed-corn for technology investment continues to run out. Club for Growth president Stephen Moore has pointed out that the pace of venture-capital funding has dropped 60% over the past 18 months. Unless investment capital flows back into firms that will reignite innovation and entrepreneurship, the nation’s economic growth will slow markedly in the years ahead.

Technology is the key. Remember, during the 1995-2000 period, following the last capital-gains tax cut, the economy expanded at better than 4% yearly. New technology investment and production contributed one-third to the economic growth spurt that sparked a wave of higher productivity and job creation. Remove the technology contribution, and the growth outlook lapses into a disappointing 2.7% trendline. At that rate, budget surpluses will not recover. Supporters of the mythical Social Security lockbox will be pulling out their hair.

But there is a way out.

The Laffer Curve teaches that economic growth (and tax revenues) is inversely related to tax rates, especially investment tax rates. By taxing capital less, more economic growth will result. Budget surpluses will come rolling in.

Those class warriors who oppose cap-gains tax relief on the grounds that only “rich people” will benefit should think again. It is business that creates jobs, and business requires capital. Policies that nurture and encourage private-sector capital formation and business creation are job creating, income creating, and prosperity creating. Everyone benefits when the economic pie grows larger.

President Bush is “open minded” about a cap-gains tax cut, telling reporters that “a capital-gains tax [cut] would pile up some revenues early in the process.” He should be more aggressive. This pro-business president should appeal to the 100 million investors and the 112 million people employed in the private-sector workforce with a full scale investment recovery plan that halves the capital-gains tax to 10%, allows faster write-off expensing for business (especially technology) equipment, and ends the double-taxation of dividends. This would also be the perfect time for Treasury Secretary Paul O’Neill to get out and stump for elimination of the corporate income tax — which costs the government and the economy more to administer than it brings in as revenue.

If some John Kerry Democrats come on board, all the better. If not, President Bush should not be deterred. At the polls, real growth policies always trump phony lockboxes.



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