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Jewish World Review Sept. 9, 1999 /28 Elul, 5759

Lawrence Kudlow

Kudlow
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Buttered bread

http://www.jewishworldreview.com -- IF THE REPUBLICANS are to win the tax battle this year, they must galvanize the political support of the 100 million or so Americans who make up the new investor class.

Split-the-difference compromises wonít do it. Class-warfare thinking certainly wonít succeed. Instead, the GOP must reach out and directly connect with the investor class. Stick to first principles. Unflinchingly. Talk their language. Bring them on board.

Just as technological innovations have transformed the U.S. economy into a cutting-edge, new-business, start-up, job-creating machine, Internet-literate and information-hungry investors are transforming the political landscape. Shareholders, homeowners and Website owners have become the invisible hand of politics. They will vote their portfolios.

For them, profit is not a dirty word. Nor is wealth. They know that in todayís economy the rich are getting richer. The poor are getting richer. And more economic freedom from tax and regulatory obstacles will lift all the boats in the rising tide even higher.

The investor class especially favors capital gains tax reduction. A recent poll by Rasmussen Research shows that 67 percent of portfolio owners favor capgains relief, compared with 46 percent of the non-portfolio owners.

Messrs. Clinton and Gore donít seem to get it. To them, itís okay to spend $1 trillion more on entitlements and social programs, but itís not okay to return $1 trillion in tax relief back to the people who earned it in the first place. This is old politics. It is destined to fail.

The GOP, however, is promoting retirement wealth, "nest egg" accumulation and individual choice. This is new politics. Good politics. Winning politics. Right now the choice between the two political parties couldnít be clearer. That is why the GOP must relentlessly stay on message.

Now, the Washington beltway media continue to obsess against tax cuts, repeatedly citing left-liberal think tank studies that purport to show the GOP plan will favor the rich and "cost" the government about $1 trillion. Along the way, interest rates will rise and the economy will be damaged.

But former Reagan Treasury department economists Gary and Aldona Robbins of the Institute for Policy Innovation have used a supply-side model that produces much different results. Their work shows that the Archer tax plan that just passed the House floor will, on average, increase economic growth by nearly one-half of one percent per year between 2000 and 2009, leading to 1.5 million new jobs and $1.5 trillion in expanded capital formation.

Whatís more, the Robbinsí model projects that these growth effects will raise federal tax receipts by $258 billion, while state and local tax revenues would rise $159 billion. Therefore, nearly one-third of the so-called static revenue loss will be recouped by the incentive growth effects of their dynamic model. Looking out at the next decade, the Robbins find that the Laffer curve effect will recoup nearly 50 percent of the static revenue loss.

Art Laffer, one of Reaganís advisors, found that rising tax rates create a disincentive to work. As taxation increases beyond a certain level, government revenues actually start to decrease, since people start disengaging from the workplace. But the flip side also is true -- as taxes fall, people feel more incentive to work, growing the tax base and protecting against an erosion of government revenues.

Hereís another point that most Washington reporters will never cover. Beltway budget estimators continue to ignore American economic history and assume that our economy is only capable of growing less than 2.5 percent per year. However, the facts show that economic growth adjusted for inflation has increased, on average, by more than 3 percent per year since World War II. Ditto for our current long wave of prosperity since the Reagan tax cuts of 1981. Actually, the Internet economy of the last three years has propelled U.S. growth to a 4-percent pace.

Using historical trends, Cato economist Steve Moore and I have re-estimated the Congressional Budget Office baseline, with vastly more positive surplus results. Instead of 2.4-percent yearly growth, we use 3 percent. Instead of 4-percent revenue growth, we use 6 percent. So, instead of the latest CBO cumulative surplus estimate of $3.4 trillion, our historical baseline yields a $5.2 trillion cumulative surplus out to 2009. This higher surplus projection is evenly divided between operating on-budget and off-budget Social Security trust fund surpluses.

Additionally, it is important to underscore the incentive effects of marginal tax-rate reductions for capital gains, estates and personal income, along with expanded Roth IRAs and 401(k)s. Higher after-tax rewards will boost the supply of high-risk venture capital, the supply of new technology advances, the supply of production output and the supply of hours worked by the labor force.

Remember Sayís Law? Really the best idea from France in a couple of hundred years. Sayís Law of Markets, named for French economist Jean-Baptiste Say, argues that lower tax rates on production will lead to more output, more jobs and more incomes to be used for consumption. In other words, we produce in order to consume.

This is important to Federal Reserve policy. It means that the aggregate supply of goods and services will rise in line with the aggregate demand from consumers. Hence, as long as the dollar is stable, there is no inflation from reduced marginal tax rates.

In the 1980s, Keynesians argued that lower taxes would re-inflate the economy and drive up interest rates. Instead, however, supply-side tax cuts generated more goods and services to absorb the existing supply of money. Between 1981 and 1987 (when policies erred by raising the capital gains tax and depreciating the dollar), inflation and interest rates declined significantly while the economy recovered. The Keynesians were wrong.

This is why it is essential that the Republican tax package be centered on growth-oriented tax-rate reduction. Targeted tax credits will dilute growth-producing supply effects. That would lead to inflationary demand.

Meanwhile, itís not the size of the tax-cut package that matters, itís what's inside the package. Static revenue compromises, whether an $800 billion package, a $500 billion package or a $300 billion plan, miss the point. The important issue is that tax cuts must contain incentive growth effects. Growth incentives matter. Static revenue numbers do not.

Gary and Aldona Robbins have estimated that capital gains tax-rate relief (not the $5,000 exclusion in the Senate plan) yields the biggest bang for the buck. For each dollar of static revenue loss from lower cap gains, they estimate a $16.87 increase in real GDP and a $2.90 rise in tax revenues. Other high-growth-impact tax cuts include estate tax reduction, alternative minimum tax relief, expanded Roth IRAs and the 10-percent personal income tax cut. Provided that the eventual bill includes these tax cut measures, then long term economic growth will rise and the budget surpluses will be maintained.

Senior Congressional staffers tell me that an eventual compromise reached this fall will probably include cap gains, IRAs, estate taxes and a 15-percent tax bracket widening (which will relieve the marriage penalty). So don't expect a perfect bill. But, the good should never be the enemy of the perfect.

However, if this one passes, more pro-growth tax reform and reduction will follow in the years ahead. Net-net, believe it or not, the tax climate is moving in a favorable direction for stock markets and the economy. The forces of light are winning. And the investor class will surely know which political party is buttering its bread.


JWR contributor Lawrence Kudlow is chief economist for Schroder & Co. Inc and 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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©1999, Lawrence Kudlow