Do mobility and prosperity trump inequality in today's America? If your answer is "yes," you're going to like President Bush's bold new tax plan. If not, you're apt to join the chorus crying "class warfare." For the heart of the Bush plan, eliminating taxes on corporate dividends paid by individuals certainly tilts toward the investor class over the working class. But in doing so, it could also lower the cost of capital, encourage innovation and investment, promote faster economic growth, and reduce poverty.
Lest we forget, that's precisely how the New Economy worked in the prosperous '90s. A rising stock market generated high rates of capital spending and innovation which produced fast, noninflationary growth, a lot of wealth, and record-low unemployment. Real wages rose and poverty fell for most of the decade. Dividends, interest, and capital gains income became much more evenly distributed as a growing investor class fueled the stock market.
Despite the recession, a wave of corporate fraud, and September 11, continued strong productivity growth shows that we're still in such a dynamic period. It may sound un-PC to say, but if the Bush tax plan gets the economy back on track and growing at its potential, increasing inequality may be a reasonable price to pay for reducing poverty. Does it matter if the rich get richer as long as the poor and the working class get richer, too?
But can the Bush plan work if passed by Congress? We think it has a good chance. For one thing, the first and second years of the $674 billion 10-year plan are front-loaded with traditional tax cuts designed to stimulate demand. At least $50 billion to $75 billion and as much as $100 billion could be pumped into the economy this year, enough to raise the growth rate of GDP by 1/2% to 3/4%. Here's how the numbers could add up: Cuts on marginal income tax rates scheduled for 2004 and 2006 are made retroactive to Jan. 1, 2003. That would be good for $40 billion this year. Accelerating the child tax credit and relief from the marriage penalty would pump in about $25 billion. The Bush plan includes extending unemployment benefits, and that could inject an additional $10 billion. The dividend cut itself is good for adding about $25 billion, and if it should spark a strong stock market rally, the resulting wealth effect could send billions of additional dollars into the economy.
The danger is that the Bush plan sends too many dollars into the economy. With interest rates at record lows and money pouring out of Washington for the military, there is a lot of stimulus surging through already. The Bush tax package could overheat the economy by 2004, putting pressure on the Federal Reserve to raise rates. The proposal will also send the federal budget deep into the red for years to come. Supply-siders say it doesn't matter because there is no connection between deficits and interest rates, and higher growth will pay for much of the deficits anyway. Deficit hawks disagree. In truth, there is no economic theory or body of data to prove either case. That worries us. The '80s supports the supply-siders' case. But the '90s backs up the deficit hawks. We prefer to be prudent and focus on maintaining a balanced budget over time. So, we suspect, would the Fed. Closing corporate tax loopholes, as the tax plan begins to do, would restore some tax revenues. So would cutting back on the huge farm subsidy bill.
The Bush tax plan is Reaganesque in its bold attempt to simplify the tax code and lower rates. After three years of desultory economic performance, it's one good way to jumpstart the New Economy.
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