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The Boom Has Legs
Why can't the naysayers see it?


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Larry Kudlow

The following numbers perfectly describe the fledgling Bush boom:

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Over the past year, following the enactment of the president’s tax-cut plan, real economic growth has increased 5 percent with only 1.6 percent inflation. After-tax profits have increased 37 percent (fully adjusted for depreciation and capital consumption). Business spending on equipment and software has grown 12.5 percent. Since last August, 1.1 million jobs have been created. Spendable income has increased 4.9 percent in real terms. Consumer spending is up 4.3 percent.

The economy is roaring at its fastest pace in 20 years, and there’s no clear reason why the prosperity trends won’t continue. Why can’t the naysayers see it?

Inside the economics profession, demand-side Keynesians are predicting a slowdown in the second half of 2004. They believe the only impact a tax cut has is when it puts more money in people’s pockets. When that money evaporates, they argue, consumer spending and the recovery at large deflates.

Supply-siders have a completely different view. Uncle Sam’s tax bite on investment has dropped by nearly 50 percent as a result of lower tax rates on dividends and capital gains enacted last year. Such tax incentives have staying power. So does the incentive effect of 7 percent income-tax relief across all IRS brackets. (Small businesses, don’t forget, are the biggest beneficiaries of lower personal tax rates.)

Keynesians don’t recognize it, but tax incentives matter enormously. They change economic behavior. When the after-tax returns to work and investment are raised, you get more of both. That’s why investment funding of business and the stock market has exploded over the past year. That’s also why more people are working at lower tax rates and taking home more pay. 

The incentive power of tax cuts, on the margin, is the principal force behind the Bush boom. Just as economic growth exploded after the JFK tax cuts of the 1960s, the Reagan tax cuts of the 1980s, and the Clinton-Gingrich tax cuts of the 1990s, economic takeoff is occurring today. And the incentive effects of the Bush tax cuts won’t run out for at least four years — possibly much longer if voter’s deliver the president a second term.

Keynesians see the world only through the eyes of consumer demand.  But supply-siders know that consumers derive their income and spending power from new job creation. It is business that creates jobs. And it is business that requires investment funding from capitalists who put their money at risk.

The supply-side trajectory is from tax cuts to investment funding to jobs. The Bush tax cuts relieved the double and triple taxation of investment, and today the jobless recovery is over. This year alone, we’re on track to create 2.6 million new jobs. Not even uncertainties over the war on terrorism have been able to smother the cascading tide of job-creating investment funding at lower tax rates and higher after-tax returns.

By the way, lower taxes are also counter-inflationary. If inflation is classically defined as too much money chasing too few goods, then the wave of goods production unleashed by new tax incentives will absorb new money created by the Federal Reserve, thus preventing any outbursts of inflation. 

The Fed will move to normalize its base policy rate in the months ahead, as they should. An emergency 1 percent fed funds rate is no longer necessary. Meanwhile, the combination of lower taxes, record productivity, and more rapid economic growth will keep inflation in a manageable 2 percent zone.

The Congressional Budget Office predicts a mere 2.8 percent annual growth rate of GDP in the years ahead. This phony baseline misses all of the supply-side points. At 3.2 percent productivity gains, with a normal 1.5 percent yearly rise in population growth, the U.S. economy’s potential to grow is rising above 4.5 percent a year. At this rate budget deficits will evaporate rapidly as the economy quickly marches toward full employment.

According to an internal OMB document published by the Washington Post, the administration is making a new push for spending restraints in next year’s budget, which will help leverage economic growth into faster deficit reduction. Timely vetoes of the pork-barrel highway bill and a defense appropriation that fails to close unnecessary military bases in the U.S. would also send a strong deficit-cutting message. 

The tax-cut-driven Bush boom has legs. It is no one time event. It will maintain strong growth at low inflation for years to come. And it will send an important signal to our terrorist adversaries: We’ll have ample resources to guarantee your defeat. Reagan sent the same message to the former Soviet Union when he cut taxes in the Cold War 1980s. It’s exactly the right message. Bush is sending it loud and clear.

— Larry Kudlow, NRO’s Economics Editor, is CEO of Kudlow & Co. and host with Jim Cramer of CNBC’s Kudlow & Cramer.



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