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A Bill in The Right Direction
The House stimulus plan is not perfect, but we'll take it.


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Larry Kudlow

While critics on the Left and Right continue to shoot at the House Republican tax-cut plan, upward-moving stock markets have the more positive take: never let the good be the enemy of the perfect. On October 5, the same day the terrible jobs-loss report was released, President Bush announced at New York’s Ground Zero that he wanted a new round of tax cuts for individuals and businesses. Since then, stock markets have been cheering.

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At least some help is on the way.

Were it my choice, the capital-gains tax would be eliminated altogether, as would corporate taxes and all levies on saving and investment. The top personal rate would be around 15%, and tax-free IRAs would be unlimited. However, much as these moves would unleash the entrepreneurial spirits and pull us out of the economic doldrums, wartime politics are not yet ready for a major tax-reform and simplification plan.

Instead, tax changes will be incremental — but even on this score the stock markets like what they see.

In the House bill, at least a sizable chunk of money will be turned back from the government to the private sector, which is badly in need of help. In recent years, Washington’s obsession with budget surpluses has created a public-sector prosperity at the expense of a private-sector downturn. Just in the last two quarters, while federal, state, and local spending has grown at a better-than 5% pace, private-sector activity (less trade) has shrunk by 0.5%. Government saving has increased and its borrowing has declined, while saving by individuals and businesses has slumped and indebtedness has surged.

Here’s more proof of how hard the government has hit the private sector. Since the mid-1990s, average tax rates on individuals increased to nearly 16% from 12% while the overall federal tax bite jumped to near 21% — a record. Just in the last few years, the falloff in after-tax personal income resulted in a $250 billion decline in personal savings — a mirror image of the $150 billion rise in the federal surplus. In short, Uncle Sam’s gain has drained vital private-sector resources and sapped economic dynamism and energy everywhere.

The House tax bill begins to replenish some of these lost private-sector resources, especially on the business side. Of the $100 billion static-revenue cost of the bill, roughly $70 billion covers business tax cuts through increased expensing, repeal of the corporate alternative minimum tax, a generous five-year carry back of net operating losses, and other tax-relief measures for large and small firms. Business cash flows and profitability will be strengthened. Technology equipment purchases and production will be cheaper as obsolete Y2K-related spending in 1999 is replaced in the next year or two. This is why tech stocks are up 20% over the past five weeks.

This is long-overdue relief for American business, which has born the brunt of this recession. As a little known factoid, business income has fallen 15% over the past year, even while consumer income continues to rise by nearly 3% (both are adjusted for taxes and inflation). Business is suffering from a credit crunch as lenders watching the corporate net-worth deflation in the stock market have boycotted loans for working capital.

In the great tax-cutting waves launched by John F. Kennedy in the 1960s and Ronald Reagan in the 1980s, tax-cut bills included business-investment incentives similar to the ones in the House Republican bill. That Congress and the White House ignored business in the tax-cut bill passed last spring was a big mistake. The current bill sponsored by Ways and Means Chair Bill Thomas (R., Calif.) at least goes part of the way to remedying that error. Over the next three years, the Economic Security and Recovery Act of 2001 will replenish business resources by nearly $150 billion, while turning $65 billion of government-held tax revenues back to individuals and families.

It is axiomatic in free-market economic thinking that private-sector individuals and firms will spend and invest their money more wisely than government will. And while most media commentators won’t acknowledge it, it is business that creates jobs, and business requires capital investment to hire more workers, generate greater productivity, and increase real wages.

Even with its many imperfections, the House bill at least moves the tax pendulum back in the right direction. The rising stock market understands this, and knows that the bill will help to refinance business and re-energize the economy. Once that’s accomplished, perhaps we can finally get down to the serious work of a full tax-reform and simplification plan. That effort is long overdue.



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