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Jewish World Review June 4, 2001/ 14 Sivan 5761

Lawrence Kudlow

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Some Good News, After All

http://www.jewishworldreview.com -- THE new tax bill is catching a lot of flack from purists bemoaning the paltry size and glacial phase-in of the rate cuts. No question, an ideal package would have cut marginal rates deeper and faster than the bipartisan legislation now awaiting President Bush's signature. It also would certainly have included action on capital gains to help reenergize the market's risk-taking spirits.

But given the political realities under which this administration entered office in January, accentuated now by the Senate's pending flip to Democratic control, enactment of the tax cuts - however imperfect - should be seen as a signal achievement. Had Vermont Senator James Jefford's defection from the ranks of the GOP come even a month ago, this tax bill in all likelihood would have never seen the light of day.

From a supply-side perspective, the bill actually incorporates some important new pro-growth incentives that have been largely overlooked, perhaps because they're not found in the usual places. Supply-side tax analysis typically is most concerned with the upper end of the progressive marginal rate structure, and for good reason.

The top rate is critical to the decisions of economic activists who avoid the levy simply by not engaging in activity rendered uneconomic when taxed at the highest rate. To the extent that reductions in the rate enhance marginal expected after-tax returns, capital and labor will seek higher-risk income-producing opportunities, improving growth prospects. The Bush plan, as we've already noted, represents positive change in that regard. Over the next five years it could raise trend economic growth to 3.9% from 3.5%.

Before a taxpayer can become eligible (or liable) to pay at the highest rates, however, he or she must climb the ladder of economic opportunity, building personal resources that pay off over time in rising earning and wealth-creation potential. At the foundations of entrepreneurial capitalism, it's essential that the aspirations and initiative of budding activists not be faced with stifling tax penalties on the results of their endeavors. The lower the tax hurdle at these levels, the greater the potential long-run economic returns. Here, the new tax structure should help significantly seeding opportunity for expansion of grassroots economic activity.

With creation of a new 10% bracket, expansion of the 15% bracket, and the three-point reduction of the 28% rate, burdens on the first $100,000 of taxable income stand to fall significantly, especially for married couples filing joint returns. Under current law, married couples filing jointly face a jump in the marginal rate from 15% to 28% at $45,200 of taxable income, an 86% hike. When fully phased in, the bill will establish a new 10% rate on the first $12,300 of income on joint returns, with the 15% threshold running from that point up to $57,050 in current dollars (the thresholds are indexed to inflation).

Expansion of the 15% threshold was put through under the moniker of "marriage penalty relief," and was structured to raise the end point of the 15% threshold for joint returns to a level double that of unmarried individuals. Of course, that's all to the good. Whatever the motivation, though, the fact is the changes will have positive dynamic effects.

On the first $57,050 of taxable income, the burden faced by couples filing jointly will be reduced by 21%. The after-tax return on the marginal dollar earned between $45,200 and $57,050, taxed at 15% rather than 28%, will rise by 18%. At the same time, with the 28% rate coming down to 25%, the effective tax rate on the first $100,000 of taxable income on joint returns drops to 18.7% from 22%, a 16% cut.

That's a significant improvement in the after-tax incentive to supply labor and entrepreneurial talent to the market at these income levels. On top of the other benefits, it should also help pull in new labor force participants from among the ranks of those now considered "unemployable." Unfortunately, though, none of this is going to happen any time soon. Due to the strictures placed on the tax legislation by the absurd budget accounting rules, expansion of the 15% bracket is slated to be phased in over four years, beginning in 2005.


JWR contributor Lawrence Kudlow is chief economist for CNBC. He is the author of American Abundance: The New Economic & Moral Prosperity. Send your comments about his column by clicking here.

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