George W. Bush’s tax-rate cuts are changing economic policy worldwide — of course, for the better. The global reaction to U.S. domestic policy today is reminiscent of the early 1980s when President Reagan’s reforms forced Europe to react and try to catch up. Back then, Margaret Thatcher argued that it was embarrassing that the highest marginal tax rate in the U.S. was lower than the lowest rate in the U.K. Europe as a whole reacted and began a broad-scale reduction in personal income-tax rates. The reforms weakened Eurosclerosis and gave rise to a resurgent European economy.
Since then the Europeans have adopted a common currency with the single objective of keeping the inflation rate below 2 percent. In fact, one can argue that the European Economic & Monetary Union (EMU) has a monetary policy that is superior to that of the U.S. The EMU mandate is to keep the EMU inflation rate at less than 2 percent, something they could easily do. In contrast, although Federal Reserve chairman Alan Greenspan is loosely following a market price rule, the U.S. has no such explicit and clearly achievable inflation target. But the reaction to the U.S. policy changes of the 1980s continue to this day.
And today, the failure of a Keynesian policy mix in Japan — the country’s stimulus package of easy money and higher spending has failed miserably — combined with the positive policy changes going on in the U.S. have prompted European countries to react with the only perceived policy option at their disposal — tax-rate reductions.
And the impetus for lower rates has been given an added boost. In Britain, tax increases in the budget may have had a more serious effect than the treasury expected. U.K. unemployment rose just as the rise in the national insurance contribution took effect. An about face is in order.
Germany is an even more interesting case. Until recently Germany had experienced a policy paralysis, partly because the Europe Growth and Stability Pact forced European countries to embrace an austere static approach to deal with their budget deficits. However, after a two-year funk, the Germans are set to reactivate their economy. German Chancellor Schroeder announced plans to accelerate the German tax-rate cuts in an attempt to inject life into the German economy. The highest rates will fall to 42 percent, just below the 41 percent top rate in the U.K.
But that’s not all. For the first time since 1954, the IG Metall Union of metalworkers and engineers failed to win concessions. The union was trying to gain shorter working hours for workers in the former East Germany, and the defeat was a major one — it could very well signal a shift towards greater flexibility in the German labor markets. That will go a long way toward increasing Germany’s competitiveness.
The German budget actions were welcomed by France, which reacted to the news by promising to boost growth via tax-rate cuts. Prime Minister Jean-Pierre Raffarin’s government has already reduced income taxes by 6 percent. Recall also that President Chirac in his re-election campaign promised to cut income taxes by one third between 2002 and 2007.
Many of the European governments have now taken the German and French cue. The Polish government has approved a cut in the corporate tax rate to 19 percent by 2004 from the current 27 percent, and they are doing so for all the right reasons. Prime Minister Miller said that the rate cuts should improve Poland’s competitiveness. In addition to rate cuts, Poland is planning to streamline its regulatory burden.
Other European countries are contemplating similar rate cuts. The Europeans are now competing and reacting in the areas where they have fallen behind U.S. economic policy — tax-rate cuts.