How to grow the economy

Posted: Jan 09, 2003 12:00 AM
WASHINGTON, D.C. -- The president's economic proposals unveiled in Chicago Monday have ignited a debate between Official Washington and the administration. The administration has some ideas about what makes an economy tick. As the president put it in Chicago, "The role of government is not to manage or control the economy." Rather, government's economic role, he declared, is "to remove obstacles standing in the way" -- for instance, taxes. Official Washington seems to have no ideas for economic growth other than to raise taxes. Admittedly that always helps Washington's economy grow, but what about the rest of the country? Two decades after President Ronald Reagan's tax cuts opened the floodgates on the longest, lushest period of economic growth in American history, most of Official Washington remains in the dark as to how it happened. In fact, many Democrats seem not even to know that it happened. In 1992, the Clintons campaigned as though the American economy were in a Depression. Listen to Hillary's response to the President's Chicago speech. She still thinks we are in a Depression. Actually, as one of the economy's most accurate observers, Brian Wesbury, has written, "Given the events of this past 18 months -- war, terrorism and corporate shenanigans -- the U.S. economy's growth rate of 3 percent is an absolute miracle, a clear sign of robust productivity growth." Of course, this economy could still use a vitamin boost. Growth at this point in a recovery should be in the 5 percent range, not 3 percent. The boost that the president obviously favors is tax cuts, particularly marginal tax cuts and taxes on dividends. Most of Official Washington views the tax code about the way a Roman tax collector viewed the tax code under the Emperor Trajan -- as a way to feed a hungry government. The Bush administration has accepted the supply-siders view of the tax code, which is to say, as a way to encourage growth. Almost no tax encourages growth, but some taxes encourage more growth than others. A reduction in marginal tax rates encourages economic growth. To Official Washington, a reduction in marginal tax rates only means a reduction in tax revenue proportional to the size of the tax cut. But recent history refutes Official Washington. In 1980, the top federal tax rate was 70 percent. By the last year of the Reagan administration, the top tax rate had been lowered to 28 percent. Official Washington had anticipated a dreadful loss of tax revenue. In fact, tax revenue in 1990 was twice what it had been in 1980. More shocking still, the share of tax burden borne by those in the top tax bracket had increased. Economic studies by such careful students of the economy as Martin Feldstein at the National Bureau of Economic Research add to the case. Much of the revenue supposedly lost in tax cuts is recovered by the cuts' increased economic activity. Why is it that Official Washington still believes that a tax reduction means a revenue reduction? Official Washington uses a tax model that tells it so. Interestingly, it is a tax model that is always wrong. The model is based on what economists call static scoring, though it might more accurately be called "static prophecy." It never takes into account that economic behavior is influenced by taxes. It simply prophesies: higher taxes, more tax revenue; lower taxes, less tax revenue. After the president's Chicago speech, the adepts of static prophecy see those dollars left in the taxpayers' hands as merely dying and leaving a budget deficit. Yet as the Coolidge tax cuts, the Kennedy tax cuts and the Reagan tax cuts make obvious, increased economic activity follows tax cuts. With increased economic activity comes increased tax revenue -- perhaps not proportional to the size of the tax, cut but over time a growing economy is always preferable to a stagnant economy. Now that the president has adopted tax cuts as an economic stimulant, he will make his argument for them stronger by accepting a tax model that is more accurate than "static prophecy" (and less biased towards high taxes). It is a tax model that recognizes that economic behavior is influenced by taxes. Official Washington might envisage the money given up in a tax cut as dead money, but the reality is that tax cuts encourage increased economic activity and an attendant increase in tax revenue. There is a growing likelihood that the Republican Congress will adopt dynamic scoring to predict the consequence of tax policy. That is something the Bush administration should applaud. For too long, the "static prophecy" employed by the Congressional Budget Office and the Congressional Committee on Taxation has dominated debate over tax policy in Washington. Our suave president has called for tax cuts. Now let him make his case more compellingly by adopting a tax model that is accurate, "dynamic scoring" or shall we call it "dynamic prophecy"? After all, no economic prediction is ever completely accurate.