In his January 20 State of the Union address, President George W. Bush called on Congress to make permanent the tax reductions passed since he took office. The President remains confident his economic policies–tax cuts totaling some $1.7 trillion over 10 years–are boosting the economy and assuring its long-term growth.
“The American economy is growing stronger,” Bush declared to applause. “The tax relief you passed is working. The temporary tax cuts should be made permanent.”
According to Forbes.com, the Forbes magazine Web site, Bush waxed lyrical–nearly Biblical– intoning, “What the Congress has given, the Congress should not take away.” Bush had good reason for calling on Congress to act this year.
Within the next two years, key provisions of the 2001 Economic Growth and Recovery Tax Act will expire. Nearly all elements of the act disappear in 2011. As the President noted, the steady expiration of this landmark tax act will:
- reduce the child tax credit by $300;
- revive many of the worst “marriage penalties” in the old tax code;
- repeal the expanded 10 percent tax rate, which cut taxes for all taxpayers, rich and poor;
- reverse the support for capital purchases by small and medium sized businesses; and
- resuscitate federal death taxes currently scheduled to die a long-deserved death in 2010.
The worst news for the economy would come in 2011, when all of the tax rate reductions disappear and taxpayers are faced with the biggest tax increase in the nation’s history.
“Let me be perfectly clear: Failure to make the tax relief permanent would be a huge mistake and would put our recovery in jeopardy,” Treasury Secretary John Snow said in a recent appearance at the U.S. Chamber of Commerce.
Political people know tax increases commonly worry taxpayers, who then express their concerns in the next election. While the President did not mention this consideration in his State of the Union address, it doubtless weighs heavily on the minds of most members of Congress.
A more important reason to make the 2001 tax cuts permanent, however, is the harm Congress would cause the economy if it failed to do so. For most Americans, the vitality of the economy trumps nearly every other aspect of life outside the family.
According to the Boston Globe, Snow reported the tax cuts had been a “major force lifting the U.S. economy out of a recession and a prolonged period of sluggish growth.” Snow said a Treasury Department analysis showed that “without the tax cuts the unemployment rate, currently 5.9 percent, would be a full percentage point higher, and as many as 1.5 million Americans would not now have jobs.”
Snow’s report and a growing body of evidence strongly suggest the 2001 tax cuts, and additional tax cut legislation since, have significantly boosted short-term economic growth. “With adoption of the President’s policies, our projections show a solid path toward cutting the deficit in half, toward a size that is below 2 percent of GDP, within the next five years,” Snow said.
The February 3 budget estimate from the President’s Congressional Budget Office has the 2005 federal deficit projected at $363 billion. Snow’s comments point toward much lower deficit figures in ensuing years as the economy moves from recovery into expansion.
What’s leading to better growth and lower deficits?
- Business investment, a key engine of economic activity, expanded in late 2003 at the fastest rate since 1980.
- The pace of economic activity in the third quarter of 2003 jumped by more than 8 percent, which is the best quarterly increase in the gross domestic product in 20 years.
- Stock market wealth has increased by more than $3 trillion this past year, bringing overall market values near their levels during the last economic expansion.
- Worker productivity in the last half of 2003 grew nearly three times faster than the long-term trend, which means wages will rise and inflation is kept firmly in check.
This good news and more like it, however, could fade away if Congress refuses to change the temporary Bush tax cuts into permanent ones.
Tax Something, Get Less of it
Taxes raise the price of everything. If capital is taxed (as it is when taxes are imposed on savings accounts, stock dividends, and the value of land and other tangible assets), then it costs more for businesses and homeowners to borrow money from the bank. The higher cost of borrowed money means fewer houses are built and businesses are more reluctant to expand their operations. In short, you get less economic growth when capital costs more.
The same economics applies to the taxation of labor and other forms of economic activity: Raising taxes increases the cost of the activity taxed, which generally lowers its use. The pace of economic activity suffers, which ultimately means slower job and income growth.
When Congress lets a tax cut expire, it endangers economic growth. Even when it threatens to let a tax cut expire in the distant future, say 2011, investors put their money into projects that will pay out over a shorter amount of time and pull out of long-term investments, like research that will yield results only after 10 years or a new factory that must be paid off over a 20-year period. In other words, investors often view inaction by Congress to make a tax cut permanent as a signal of higher taxes–and thus prices–in the future. The economic damage is done even as Congress sits on its hands.
The President was right to call for immediately making the temporary tax cuts permanent. If Congress dithers rather than acting, it will directly shape an economic future filled with more joblessness and poverty than there otherwise would be.
William W. Beach is director of the Center for Data Analysis at The Heritage Foundation. He can be reached at [email protected].