The liberal banshees on the presidential campaign trail may be technically right that so far the Bush tax cuts have not produced a vigorous recovery. But hopefully even the most partisan left-wing economists recognize that you simply can’t judge the full effects of a broad-based tax-cut plan that’s less than two months old.
The president’s tax-cut package, which became law only in late May, slashes marginal rates on individual incomes, investor dividends, and capital gains. The combined effect of this tax relief reduces capital costs and raises investment returns by over 40 percent — making it the largest investment tax-cut program since the Civil War income tax was repealed in 1872.
Yes indeed, Ulysses S. Grant was America’s first supply-side president (he also took us back on the gold standard).
For the economic historians among you, the administrations of Warren Harding and Calvin Coolidge, guided by Treasury Secretary Andrew Mellon, constituted the second supply-side presidency. The third supply-side period was triggered in the early 1960s by John F. Kennedy. The fourth occurred under Ronald Reagan in the 1980s. The fifth was — if you can believe it — Bill Clinton’s second term. And of course George W. Bush has turned in the sixth supply-side tax-cutting administration.
The point of all this is simple: Prior to George W. Bush, all these other supply-side presidencies led directly to lengthy periods of strong economic growth and low unemployment. So, if Bush’s critics show a wee bit more patience, they will see that once again — for the sixth time in American history — across-the-board tax reduction has expanded the nation’s economic pie and created a rising tide that lifts all the employment boats.
While we wait for the latest economic miracle to unfold, it is worth reviewing why the Bush tax cuts are necessary.
Thus far the nation has come out of recession with seven quarters of relatively slow economic growth (assuming that this year’s second quarter will come in around 2 percent at an annual rate). This leaves seven recovery quarters with an average growth of only 2.6 percent yearly, a truly anemic pace when compared with past recoveries. Even worse, the last three quarters look to come in at an average growth rate of only 1.6 percent annually. Normally, the first two years of a cyclical recovery range between 5 and 6 percent growth.
This is why the unemployment rate, most recently hitting 6.4 percent, has continued to rise. The creators of jobs, namely businesses, have barely expanded thus far. If that weren’t bad enough, there’s a second barrier to job creation. Namely the nation’s productivity rate, or output-per-hour, which has increased at a 2.4 percent yearly pace since 1994. That’s nearly twice the rate of productivity gains registered in the prior three decades.
True business recoveries always register growth that is well above the nation’s long-run potential to grow. Over thirty years ago a smart Washington economist named Arthur Okun (a Democrat, by the way) coined the term Okun’s Law, which stated that the potential of the U.S. to grow was 2.7 percent yearly. So economic growth below Okun’s 2.7 percent would generate rising unemployment, while growth above that benchmark would reduce unemployment.
So in some sense, President Bush has even more work to do to bring down the unemployment rate, because Okun’s Law would pinpoint today’s economic growth potential at roughly 3.5 percent — 2.4 percent productivity plus 1 percent labor-force expansion. This is almost a full percentage point higher than the old DMZ line. More, it’s a burden that comes on top of terrorist attacks, war, energy shocks, bad weather, gross corporate malfeasance, and — until recently — a monetary policy that kept the nation dangerously close to deflation.
And that is precisely why the president is right to prescribe a stronger-than-usual dose of tax-cutting. In the longer run, the aforementioned productivity rise — itself a product of strong capital investment leading to dazzling technological advances — is a very good thing for the economy and the workforce. Indeed, the biggest beneficiary of investment-led productivity gains is the higher real wages received by American white- and blue-collar workers, whether they own capital or not.
But in the shorter run the productivity record sets a high economic hurdle over which the Bush economy must leap in order to add to the job force and reduce the unemployment rate.
But leap it will, as illustrated by the other supply-side presidents who preceded President Bush into office. Though declining unemployment may not come until later this year or early next, the huge stock market rally now in tow is telling us that Bush’s tenure will in fact follow in the footsteps of Reagan, JFK, and the others who charted a similar economic course.
Liberal banshees beware.
— Mr. Kudlow is CEO of Kudlow & Co.