Tax Cut Sniff Test

[mr mahs]

This is an article from Lawrence Kudlow a popular economist who knows what he is talking about but people choose to listen to dsome left wing liberal loon who know NOTHING about economics...

IN a last-ditch attempt to stop broadbased tax cuts, Democrats are again circulating their tired argument that current and prospective budget deficits will drive up interest rates. But if deficits do in fact send interest rates skyward, then why is the 10-year Treasury note trading near 31/2 percent - a 45-year low?

The answer: A three-year deflationary recession, not deficits, is driving interest rates lower. As the economy turned down, deficits went up.

Still, the liberals tightly link interest rates and deficits. But there is an abundance of evidence that this is a weak leak.

Japan, for instance, which has much larger deficits than the United States, has a 10-year government bond with a yield of 0.59 percent. Germany, with deficits running about the same as ours (3 percent of gross domestic product), has a 10-year government note at 3.8 percent. When President Clinton and his Treasury man Robert Rubin raised taxes in 1993, the 10-year note hit bottom at 51/4 percent. Today, with large tax cuts and rising deficit forecasts on the horizon, the 10-year is near a half-century low.

So, if deficits don't necessarily drive up rates, what does?

The preponderance of research argues strongly that inflation or deflation expectations and anticipated real returns on investment (i.e., economic growth) are the major determinants of interest rates. While there may be a connection between deficits and rates, it's a fuzzy connection.

As U.S. inflation descended from roughly 15 percent in 1980 to about zero today, long-term Treasury rates dropped from about 15 percent to 31/2 percent. During this period, as government revenues downshifted in response to disinflation, budget deficits were a recurring theme. But it was disinflation, not rising deficits, that drove interest rates lower and lower.

Washington revenue estimators, who project rising deficits in response to the tax cuts now being debated in Congress, are members of a Flat Earth Society - they intend to persuade the public that the planet is not round, and that tax cuts won't change the economy. Soon they will claim Christopher Columbus did not really discover America.

But of course he did, and it corroborated his view that the world is not flat. Similarly, lower tax rates that raise the after-tax return for working and investing do in fact induce behavioral changes.

Investors, unburdened by lower taxation, supply more capital to businesses and the economy by saving and investing more. Workers, meanwhile, supply more labor, including overtime hours worked.

And when workers and investors get busy, projected deficits from tax-rate reduction never pan out.

The so-called static revenue cost of President Bush's tax-relief plan is overestimated by one-third to one-half. Credit markets are not fooled by the resulting deficit forecasts. Neither is the public.

Tax cuts under JFK, Reagan, and Clinton (during his second term) all produced faster economic growth, more jobs, and higher tax revenues for Washington.

Indeed, Clinton's 1997 capital-gains tax cut was the driving force for late-decade budget surpluses. Revenues in this period soared as profits accrued from stock market gains and stock options. It was a near-perfect illustration of the Laffer Curve, which says, in clear terms: Tax something more, get less of it; tax something less, get more of it. The less we penalize work and investment, the more work and investment there will be.

This is Economic Behaviorism 101 - and it's a simple science that too many members of the U.S. Congress and most state governments fail to comprehend. Or do they get it?

The so-called sin taxes on alcohol, beer, and tobacco suggest that liberal lawmakers just might understand the behavioral basics of taxation.

In recent years, legislatures on every level have poured taxes on these products - especially tobacco, where the latest liberal mantra aims to save smokers from themselves. But doesn't this assume a behavioral change by smokers in response to the higher tax-cost of cigarettes? Sure does.

So why wouldn't the same logic apply to taxes on investment? Of course it applies.

If we tax investment more, we will get less investment. But if we tax investment less - including dividends, the centerpiece of the president's plan - we'll certainly get more investment.

And that's exactly what the American economy thirsts for today.