Sen. Tom Daschle and Congressman Richard Gephardt are placing partisanship above the national interest when they make the bizarre claim that President George W. Bush has talked the economy into a slowdown and perhaps a recession by telling the truth about its condition. Congressional Republicans, rank-and-file Democrats and the Bush administration should ignore this poisonous double talk and double the size of the tax rate reductions to do something serious about reviving economic growth.
If we were running balanced budgets and the economy was heading south, we wouldn't raise taxes in order to run huge budget surpluses and pay off the national debt. Yet that is equivalent in our current situation to refusing to cut tax rates sufficiently to extinguish projected surpluses.
No economic theory, Keynesian or supply-side, recommends such foolish fiscal austerity. In fact, both schools of thought sanction running temporary budget deficits if necessary to revive a sinking economy.
Straight thinkers in both parties, such as Trent Lott, Denny Hastert, Dick Armey, Robert Torricelli and Max Cleland, have suggested a sensible way to broaden the president's tax cut proposals: Reduce the overall revenue loss from the tax-cut package and provide the economy just the kind of spark it needs right now by cutting the capital gains tax rate to 15 percent and index it for inflation.
Every time the capital gains tax rate has ever been reduced, revenues from the taxation of capital gains have increased. After raising the capital gains tax rate in 1987, for example, capital gains revenues declined and six years later in 1994 still were no higher than they were in 1988. In 1997, the capital gains tax rate was reduced and capital gains revenues jumped from about $66 billion the year before to approximately $118 billion last year.
The reason for this "paradox" is that the capital gains tax is a voluntary tax that doesn't have to be paid until owners of assets voluntarily elect to sell them. When the capital gains tax rate is too high, people hold on to their assets and avoid paying the tax.
When the capital gains tax rate is too high, it is possible to lower the tax rate and unlock enough new capital gains realizations that overall capital gains tax revenues increase, even though the tax rate is lower. Research indicates that at 20 percent the capital gains tax rate is higher than its revenue-maximizing rate and that more revenue could be generated by dropping the rate to 15 percent.
Reducing the capital gains tax rate would reduce the cost of labor and make it easier for employers to retain and hire new workers. It would increase worker productivity and allow wages to rise without inflation. It would help the elderly, who own the largest share of assets. It would raise the after-tax rate of return on investment and make it more attractive for people to invest in young companies whose expected future income streams have declined suddenly since the Fed tightened monetary policy and engineered the current economic slowdown.
Start-up ventures are fragile, and most do not survive past infancy. Those that do become tomorrow's success stories, creating the next generation of technology and innovations that will spur productivity, economic growth and our standard of living to new heights. Even a minor exogenous shock to their environment early on can exterminate an entire generation of economic children, setting economic progress back years, even decades.
In a display of hubris, the Fed decided there was an unwarranted "population explosion" of new start-up companies. When it closed the monetary valve on the supply of venture capital to these economic youngsters, it altered the outlook for their survival and success. It put the economy in a vice between the jaws of fiscal austerity and deflationary monetary policy.
Everyone knew that most of the New Economy start-ups would fail, but no one knew which few of them would succeed and go on to drive tomorrow's economy. By telescoping and intensifying the creative destruction that otherwise would have occurred naturally over an extended period of time, the Fed has fulfilled its own misguided prophecy and caused enormous economic damage in the process.
Cutting the capital gains tax rate to 15 percent will not restore a healthy oxygen flow of investment capital to our economic children as long as the Fed insists on restricting the flow at the monetary valve. But lowering the tax burden on risk-taking and thereby increasing the after-tax reward for investing in new ventures will save many young firms that otherwise would die. If we get about the business of doing it immediately and making it retroactive to the beginning of the year, we just might be enough to stop the economic slide before more economic destruction occurs.