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post-September 11 spirit of bipartisanship was suddenly shattered
during a House Ways and Means Committee meeting, when Republicans
suggested a capital-gains tax cut as an emergency economic stimulus.
Charlie Rangel of New York, the ranking Democrat on the committee,
embarked on a fist-pounding tirade denouncing the Republicans for
exploiting the tragedy of terrorism to advance their “right-wing
tax-cutting agenda.” A few days later, John Spratt, the ranking
Democrat on the House Budget Committee, lambasted the capital-gains
discussion as “unconscionable” in a time of national crisis. Senate
majority leader Tom Daschle piled on, advising the White House not
to cave in to the “extreme voices” advocating a “divisive approach”
to the stimulus bill. Translation: Even in a plunging economy, congressional
Democrats will never abandon their quasi-religious opposition to
capital-gains cuts.
Unfortunately,
to preserve the veneer of bipartisanship, the White House has succumbed
to these tirades. President Bush’s economic advisers have always
— inexplicably — been unenthusiastic about capital-gains
cuts anyway, so the passionate opposition by liberal Democrats has
convinced the Bush political team that it’s now doubly wise to shelve
the idea. In a meeting with investment icon Charles Schwab, Treasury
secretary Paul O’Neill rebuffed Schwab’s plea for a capital-gains
cut, calling it a “deal-breaker.” But it’s only a deal-breaker because
the Bush economic team, representing a president with an 85 percent
approval rating, refuses to endorse the idea.
O’Neill’s
quick surrender has only emboldened the left-leaning Democratic
leadership. They are now insisting that any speed-up of income-tax-rate
cuts should apply only to the lower brackets, not to the highest
and most punitive rates.
So the White
House, which has handled the military and coalition-building aspects
of the current crisis with such mastery and professionalism, is
fumbling the economic-stimulus plan. Republicans are inching closer
to agreeing to a stimulus plan with tens of billions of dollars
in new government expenditures (which will depress the economy instead
of resuscitating it), more tax rebates (which are close to being
economically worthless), and targeted tax-rate cuts (which avoid
cutting the rates that matter most).
One problem
is that the White House apparently gets its economic advice from
all the wrong places. Bush has announced that he is “listening
to the voices of leading economists” in constructing a stimulus
package. This is dreadful news, because the vast majority of modern
business and academic economists have a wrong-headed view of how
the world works. The supply-side model that Ronald Reagan and Margaret
Thatcher employed to change the world in the 1980s is still in disrepute
with most traditional Keynesians, who found themselves cast aside
in the low-inflation, low-tax prosperity of the 1980s and ’90s.
Most “leading
economists” opposed Reaganomics. As a consequence, it is now Clintonite
Robert Rubin and Fed chairman Alan Greenspan, not Reagan supply-siders,
who are crafting the president’s stimulus plan. This administration
is clearly in search of its economic orthodoxy, and it’s being tugged
in multiple directions. Bush has described his administration’s
economic philosophy as “both supply-side and Keynesian”; of late,
the emphasis seems to be on the Keynesianism, as with the administration’s
absurd claim that the $40 billion emergency spending enacted the
week after September 11 would provide a quick “stimulus to the economy.”
(This contention prompted Congressman Paul Ryan of Wisconsin —
one of the rising stars of the House GOP — to send around a
copy of a famous chapter from Henry Hazlitt’s classic Economics
in One Lesson. The chapter, entitled “Broken Windows,” reminds
us that breaking windows so as to create jobs repairing them is
not an intelligent way to build prosperity.)
Of course,
the demand-side Keynesian model preaches that economic growth is
driven by consumer and government purchases, and I am told that
the Fortune 500 CEOs who have visited the White House since September
11 are almost universally obsessed with this idea. They have begged
the president to get customers into their stores. The problem with
this idea is that it has already been tried, and failed. Japan —
with the fastest-growing government spending and debt of any nation
in the industrialized world — has been trying it for eleven
years now, and continues to sink deeper into the economic mire.
In early October, the despairing Japanese finally cut their capital-gains
tax.
The alternative,
supply-side worldview holds that prosperity is achieved by driving
down the cost of capital through sound money, low tax rates, a non-intrusive
government sector, and free trade. Today’s supply-siders generally
believe that the economy is being dragged down not by insufficient
consumer demand but by a virtual disappearance of investment capital
over the past year or so.
And to fix
this, capital-gains tax cuts are crucial. They would raise asset
values instantaneously, by reducing the tax penalty on all new and
existing capital investment. They would reverse stock losses and
stimulate new investment — which is what the economy needs
most. Former Reagan economist Gary Robbins, now of the Institute
for Policy Innovation, has found in a new study that dollar for
dollar, there is no tax cut that is more stimulative to the economy
than a capital-gains cut: You get $10 of economic stimulus for every
$1 revenue loss. (By contrast, the Democrats’ payroll-tax rebate
is worth less than 50 cents for every dollar of cost.)
Here again,
the president is receiving bad advice. The Bush team has apparently
been frightened by the argument that a capital-gains cut would lead
to a quick sell-off of stocks, as investors rush to cash in on past
gains; this would further depress the stock market. Historically,
however, the stock market has risen, not fallen, after a capital-gains
cut. After the most recent capital-gains cut in 1997, the Dow went
from 7,000 to a peak of 11,000. Here’s why: A share of stock is
valued at the expected future earnings of the company — after
all taxes are accounted for. When the capital-gains tax is lowered,
the after-tax value of the earnings of every company in America
rises. The only possible way that the stock would fall in value
is if investors were willing to sell stock that is now worth more,
for a lower price.
There’s also
a way to guarantee that a capital-gains cut won’t depress the market:
Cut the rate from 20 percent to 10 percent on all gains earned after
September 11, 2001, but not on gains earned before then. This would
mean that no investors would have an extra incentive to sell stocks,
because they would still have to pay the old rate, but new investors
would have a strong incentive to buy stocks because the tax in later
years would be cut in half. The value of stocks under this plan
would have to rise. (House Whip Tom DeLay has already proposed this
sensible compromise.)
This debate,
alas, is not primarily about economics, but about diplomacy with
the Democrats. The Bush policy team’s preference on almost all domestic
issues now is to advance issues that are perceived as less partisan.
This makes some sense: Bush has risen above politics and party in
recent weeks, to the level of a statesman trusted by almost all
Americans. The problem is that when this principle is extended to
economics it means that we get a steady onrush of bad policies:
lavish giveaway packages to the airline industry, extended unemployment
benefits, the federalization of 15,000 airline workers, another
$5 billion in Department of Edu cation spending, the most expensive
farm bill in American history, and so on.
Worst of all,
bipartisanship has given Tom Daschle and Dick Gephardt a de facto
veto over economic-policy decision making. There are two problems
with that: First, Gephardt and Daschle are clueless as to how to
stimulate the economy. Second, even if they weren’t economically
illiterate, they might not support an economic-revival plan that
would ensure that Republicans retain the House and recapture the
Senate in 2002. As Rep. Pat Toomey, the Pennsylvania Republican,
notes: “Our GOP leaders need to understand that a slumping economy
is not necessarily contrary to Dick Gephardt’s political interest.”
So in the
name of bipartisan cooper ation, George W. Bush may commit a grave
political and economic sin: signing a bipartisan stimulus package
that doesn’t stimulate. And if that happens, even a great military
victory may not be enough to maintain these stratospheric approval
ratings for long. Just ask the president’s dad.
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