Editorial: TAXES: Going for Growth

National Review, Jan 27, 2003

Let's not beat around the bush: The president's new tax cut is the boldest free-market initiative since 1981, and it deserves the wholehearted support of conservatives and everyone else. We were not able to support Bush's last large tax cut, the one enacted in 2001, nearly as vigorously. But the new plan completes, and remedies the principal defect of, the old one. We worried that the earlier tax cut, designed not to alarm Washington's deficit-phobes, was phased in too slowly to have any salutary effect on the economy. Tax rates would not drop all the way until 2006. Under the new plan, the rates will drop immediately.

President Bush also proposes an immediate end to the double taxation of dividends. Under current law, corporations pay taxes on dividends before they are distributed and then most individuals who receive them pay taxes again. Since interest payments are deductible while dividends are not, companies have an incentive to raise capital by incurring debt rather than issuing stock. The double tax also leads companies to hold on to their earnings rather than pay them out in dividends, which means that money is not invested where it could best be used. Artificially depressed dividend payouts, meanwhile, deprive investors of a way to measure the solidity of a company's profits. Under Bush's plan, however, dividends would be taxed only at the corporate level, thus removing the distortions -- and, in all likelihood, boosting stock prices nicely.

Bush's plan also ends the marriage penalty immediately, and expands the child credit. Some supply-side conservatives have quarreled with the design of the tax credit, but it seems to us a worthwhile (though crude) corrective to the anti-natalist biases of Social Security.

The president's plan was wise not only in what it included but in what it excluded. Bush left estate taxes alone, no doubt figuring that repeal is sufficiently popular to pass on its own. He also declined to give in to state governments' clamor for a federal bailout that would save them from the consequences of their own profligacy.

The Democrats' plan is to give money to the states and to hand out one- time tax rebates. Their plan would do nothing to improve incentives to work, save, and invest. It seems better calculated to increase dependency on the federal government. Democrats had been discussing one promising idea, a payroll tax cut, but they left it on the shelf. They are denouncing Bush's plan, especially the dividend tax cut and the drop in the top marginal tax rate, as a budget-busting gift to the rich. But most Americans now own stock, and will benefit from a rising stock market.

As for the deficit, it is economically unimportant. It may raise interest rates by some small amount; but the tax cuts, and especially the tax cut on dividends, will lower the cost of capital by more than enough to compensate for this effect. Politically, the deficit will not matter much to Bush's political future. If the economy is weak in 2004, he will be in trouble deficit or no deficit. If it is strong, voters won't care about the deficit.

Bush thus has more to gain from a sound economic policy than from political craftiness. He also now has the political clout to get sound policy enacted. Finally, he benefits from an opposition that is off on an ideological bender. Full speed ahead.