President Bush has proposed a bold package of tax cuts that will rejuvenate both economic growth and his supply-side credentials. Yes, his plan to eliminate double-taxation of corporate dividends is a welcome tonic for the stock market and for fundamental tax reform. Yes, it forces Democrats back on the defensive while simultaneously baiting them to indulge their class-warfare instincts at the expense of their (crumbling) appeal to the new investor class.
But the early spin from the Right, while correct, is incomplete.
There are some political and economic subtleties imbedded in the president’s plan that have largely escaped notice so far. Here are three issues where the administration’s proposals could well advance important conservative policy goals over the next few months and years.
Social Security and Medicare reform. Bush and his advisors are already signaling their willingness to move forward with market-based reforms of these core elements of the federal entitlement state. While I think they are right to do so, and I strongly believe that there is a political constituency for it, there are risks. The concept of transforming major federal entitlement programs into private plans or accounts sounds great in theory, but many doubt in practice that average Americans can be trusted to make their own decisions about their financial futures and assets.
That’s why I’m intrigued by the late addition to the president’s growth package of “Personal Re-Employment Accounts” for the jobless receiving unemployment benefits.
I have long thought that our creaky unemployment insurance system, technically run by state governments but in effect a federal entitlement, would be an excellent place to try personal accounts as a trial run for broader Social Security reform. Let workers direct a portion of the payroll taxes that employers “contribute” on their behalf into private accounts from which they can draw, at their discretion, to retrain or obtain new employment should their job disappear.
The president takes a step in this direction with his Personal Re-Employment Accounts, which would be funded at $3,000 a pop. That money would be available for job training, child care, moving costs, or other expenses associated with getting a new job, and workers can pocket what they don’t during the job search.
Economists have long observed a major downside of unemployment insurance (UI) benefits: they tend to lengthen spells of unemployment. Some jobless recipients try to maximize their UI benefits instead of going back to work as quickly as possible — a practice that clearly has deleterious consequences for the economy, but arguably also for the workers themselves. Perhaps the president’s modest idea will form the basis for a more fundamental restructuring of the UI system, in a way that gives individuals control over their own emergency savings (which is what UI accounts really are) and incentives to keep the money invested rather than to withdraw as much of it as possible over as long a period as possible.
Government spending boondoggles. Working primarily with the state and local levels of government, I have seen first-hand the foolishness and, sometimes, corruption associated with a longtime quirk in the tax code that makes borrowing costs for governments lower than those available in the private sector. The main problem is that returns on municipal bonds are tax-exempt, thus allowing the interest rate to fall far below what businesses can obtain from banks or other lenders. As a result, we have a confusing array of special-tax districts, public-private partnerships, state-university-run enterprises and corporate campuses, and public sports arenas and convention centers — many of them “justified” as a smart way to extend the government’s tax-preferred borrowing privileges to economic-development efforts.
The president’s plan doesn’t tax municipal-bond returns to establish neutrality in the capital market — I guess we’ll have to wait on that — but it does make corporate stocks that pay dividends a more attractive investment for seniors and others looking for steady, low-tax income. This will put competitive pressure on government bonds and likely force their rates up a bit, as state lobbyists are already wailing about. Good. Maybe the disgusting country-wide parade of taxpayer-subsidized, pork-barrel projects will slow down a bit.
Capital-gains tax relief. Some free-marketeers have expressed dismay about the possibility that the elimination of the dividend’s double-tax will steer investment capital away from risk-taking, growth-oriented businesses and towards old economy stalwarts and utility companies. That misses the point, I think (the benefits of unleashing dividends as a financial tool are likely to be as much about changing the relative power of corporate executives and their shareholders as anything else), but I also suspect that some of my colleagues are underestimating the Bush administration here.
They know very well that capital gains will retain a version of the same double-taxation problem that the Bush plan solves for dividends, and that growth prospects might be hampered if capital-gains taxes are kept artificially high. Might this not become obvious in the near future, perhaps setting the stage for a subsequent legislative “fix” of the problem through capital-gains tax relief? Sounds like a plan.
Like it or not, free-market reforms won’t happen simply because they are meritorious. There must be a political strategy to shepherd them through an uninformed and often hostile Congress (including members of both parties) that is all-too-easily swayed by demagoguery and biased media coverage.
Kudos to the Bush administration for coming up with some ways of advancing important and welcome ideas — albeit through the back door rather than the front.
— John Hood is president of the John Locke Foundation and author of Investor Politics.