Politics & Policy

A Rising Tide . . . In More Ways than One

The wisdom of the JFK-Reagan-Bush tax-cut model.

Pete du Pont, former governor of the State of Delaware, recently documented the success of the Bush 2003 tax cuts in an editorial for the Wall Street Journal. Republicans running for office in 2006 should wear lapel pins that refer to du Pont’s statistics, to let the electorate know that the current economic expansion is not only of historical magnitude, but a Republican invention — an expansion that is being fought tooth and nail by virtually every Democrat in Congress.

 

#ad#What is strange about this story is that Democrats used to be for tax cuts. As du Pont pointed out, John F. Kennedy espoused revenue-producing tax cuts when he said that “an economy hampered by restrictive tax rates will never produce enough revenue to balance our budget, just as it will never produce enough jobs or enough profits.”

 

The Democratic shift away from JFK economics is mind boggling: Only 2 of 48 Democrat senators and 7 of 205 Democrat representatives voted yes on the Bush tax cuts of 2003. If JFK’s famous analogy that “a rising tide lifts all boats” can’t be understood by modern-day Democrats, they need to spend some time reading about their hero’s concept of tax reduction (or just read du Pont’s Journal essay).

 

The rising tide of economic progress is being widely documented in the financial media: 5.3 million new jobs have been added in the last three years, hourly wages are up 3.9 percent in the past year, the economy hit a 4.6 percent annual growth rate in the second quarter of 2006, and the percentage of Americans earning more than $50,000 rose from 40.8 to 44.2 percent in just the two years ended in 2004.

 

Not only is the tide rising for individuals, but corporate profits are booming; corporations have never been wealthier, with hundreds of billions of dollars in cash on hand and double-digit profit growth for seventeen straight quarters.

 

The 2003 tax cuts, rather than collapse the economy and balloon the federal deficit (as Democrats forecasted), have actually ballooned federal revenues. According to du Pont: “Federal tax receipts increased by 15% — $274 billion — last year and 13% — $206 billion — in the first nine months of this fiscal year . . . Looking ahead to the end of this fiscal year, total inflation-adjusted government receipts will likely be 23% above 2003 when the Bush tax cuts were signed into law.”

 

The response from the pessimists? “Revenues aren’t as high as the Republicans projected they would be”!

 

The Democrats rely on the belief that tax-rate cuts reduce government revenues. They quote studies such as the CBO’s “Analyzing the Economic and Budgetary Effects of a 10 Percent Cut in Income Tax Rates” as the basis for the “fact” that tax cuts lose government revenues. The CBO makes the following assumption: “This brief analyzes a stylized 10 percent reduction in all federal individual income tax rates — for example, an individual facing a 25 percent federal marginal tax rate would see that rate fall to 22.5%.” But the model totally fails to analyze the effects of tax-rate cuts. More, while the CBO did create a model that cut tax rates by 10 percent, it cut tax rates across the board. In other words, all taxpayers benefited from the tax cuts in this model.

 

When Jack Kennedy cut taxes, he reduced the highest marginal tax rate. Ditto for many of the Ronald Reagan tax-rate cuts and the Bush cuts of 2003. When the top marginal tax rates are cut, the likelihood is highest that a Laffer-curve effect (whereby taxpayers move out of the “prohibitive zone”) will drive an increase in revenues to the Treasury as incentives to work, invest, and save rise accordingly. The recent surge in tax revenues, unexpected by the Democrats, is directly attributable to this relationship.

 

 

There is, importantly, another aspect of the Laffer curve where a reduction in marginal tax rates will reduce tax revenues. When tax cuts arrive in the “normal” part of the Laffer curve, they do not deliver sufficient incentives to trigger an increase in work effort that will generate more tax revenues. When Democrats argue that across-the-board tax cuts reduce tax revenues, it is only the cuts that land in the normal zone that will do so.

 

Clearly, the best strategy for Democrats who don’t want to lose tax revenues is to only cut tax rates on those individuals who currently reside in the prohibitive zone of the Laffer curve, while keeping tax rates the same (or actually increasing them) for those individuals who are in the normal zone. This is the true description of PAYGO.

 

Given the recent data provided by Gov. du Pont and the logic of the Laffer curve, it is obvious that Democratic proposals to roll back President Bush’s tax cuts will do substantial harm to the economy.

 

In other words, a falling tide will strand all boats.

 

– Thomas E. Nugent is executive vice president and chief investment officer of PlanMember Advisors, Inc., and principal of Victoria Capital Management, Inc.

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