The
Economic Imperative
Bush
and the Republicans cannot let this drop.
By
Stephen Moore, president of the Club for Growth, from the November 5,
2001, issue of National Review
October 25, 2001 8:00 a.m.
he
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.