With President Bush safely reelected and the Republicans still in control of Congress, it is natural to ask: What policy changes are likely for a second-term agenda, and what effects will these changes have on the economy and the markets? If nothing else, the initial conditions for the Bush second term are much different than those of his first.
We now know, and the National Bureau of Economic Research confirms the fact, that when President Bush first took office the economy was sliding into a recession. According to the NBER, the recession began in March 2001. In contrast, recent news indicates that the economy is currently expanding at a 3.7 percent annual rate.
Assuming the Republicans retain control of Congress during Bush’s second term, the president certainly does not have to worry about tax-rate increases. In fact, the absence of rising tax rates and new regulations should bode well for the economy in the short to medium term. But Bush’s battle is to make his first-term tax cuts permanent and, if possible, further extend his agenda of eliminating the double taxation of income. The president still does not have a filibuster proof majority, so this will be difficult — but not impossible.
Timing, as they say, is everything. History has shown that a pre-announcement of a tax-rate cut delays the pace of economic growth until the tax-rate cut takes effect. The Reagan and Bush tax-rate cuts are just two examples of this. The corollary is that a pre-announcement of a tax-rate increase leads to a temporary surge in economic activity as people advance their income recognition in order to realize the income during the lower tax-rate years.
The bulk of the increases in current tax rates due to sunset provisions will not begin until 2009 and will continue through 2011. (Among these are taxes on capital-gains, dividends, income, and estates, which are scheduled to rise, and credits/deductions for children and joint-filers, which are slated to shrink.) In other words, the tax-rate increases will not take place until after Bush has left office. More important, the scheduled tax increases will shift the timing of income recognition away from 2009 and beyond and into 2008 and earlier. So, the timing of the scheduled tax increases will make the economy stronger during the tail-end of the Bush presidency, which in turn will make it easier for him to extend the tax cuts. If he is popular enough at that time, he may be able to make them permanent.
Borrowing a page from Reagan’s second term, President Bush has the opportunity to alter the course of the world for the next two decades.
On national defense, the Reagan parallel is clear. Reagan conquered the Evil Empire and Bush has a chance of conquering the axis of evil. Early on, it was not clear that Reagan was going to prevail, but everything fell into place during his second term. President Bush could have equal success — if he does not, the world will be a much more dangerous place.
A second opportunity for Bush is one that Reagan did not really have: The president may be able to make several Supreme Court appointments as well as many more selections for the lower courts. His choices will shape the courts for years to come.
His decision for the next Federal Reserve chairman will also be critical. Alan Greenspan’s term at the Fed will expire in 2006. If Bush chooses his replacement well, the U.S. will continue enjoying the price stability that the financial markets have grown used to over the last 25 years.
Finally, on tax cuts, a Bush-Reagan parallel seems there for the taking. President Reagan pushed for a second round of tax-rate cuts at the end of his term. His cuts were based on the premise of delivering a broader tax base with a flatter tax rate, and the highest marginal tax rate was reduced to 28 percent. Bush, with his ownership-society vision, has articulated a program aimed at eliminating the double taxation of income. So, in many ways, one can argue that the ownership society will also produce a lower tax rate and a broader tax base.
The odds are in Bush’s favor. Freed from the burden of a reelection campaign, he will not make policy mistakes based on political calculations. (Remember the steel tariffs?) If he follows his instincts and is guided by his core beliefs — which parallel quite well with those of Ronald Reagan — he will hopefully produce Reagan-like results.
– Victor Canto, Ph.D., is the founder of La Jolla Economics, an economics research and consulting firm in La Jolla, California.