August 30, 2001

August 30, 2001 | Commentary on Taxes

Economy Demands a Bigger Tax Cut

Congressional liberals seem to have come down with a bad case of "buyer's remorse." They're using the prospect of a smaller-than-expected budget surplus to say they wish they could take back a portion of President Bush's tax cut.

But if they understood how tax cuts work, they'd realize how absurd this is. If anything, Congress should increase the size of the cut, or at least speed up the time when all its provisions take effect. The economy has been softening since the middle of last year -- long before the cut was approved -- and lower tax rates are a sure-fire way to restore growth.            

Unfortunately, the Bush tax cut is back-loaded. The lower rates aren't fully phased in until 2006, and the reduction for the next three years is only one percentage point. The death tax, meanwhile, isn't repealed until 2010. Worse, thanks to arcane Washington budget rules, all the tax cuts disappear in 2011.

A future tax cut is better than no cut at all, but it won't help the economy now. That's why lawmakers should immediately -- and permanently -- implement all the cuts.

But that should be just the beginning of the tax-cut agenda. Other steps could help rejuvenate the economy and make America more competitive globally. Lawmakers should:

Cut capital gains taxes. If there's an elixir for economic growth, it's this. The money used to invest in new businesses is the lifeblood of any economy, but risk-takers are hindered by an onerous and complicated capital gains tax. Ideally, the tax should be repealed, but reducing the rate would be a good interim measure, especially since history shows that lower capital gains tax rates lead to more tax revenue rather than less.

Stop taxing income earned abroad. American companies have a hard time competing in the world economy because the Internal Revenue Service taxes the income they earn in other nations -- even though that income is already taxed by the countries where it is earned. This added burden is so harmful that some companies, such as Fruit of the Loom, are actually moving their headquarters out of the United States. Rather than chase businesses away, Congress should shift to a territorial tax system, which is based on the common-sense notion that governments only tax income earned inside their borders.

Repeal limits on IRAs. Individual retirement accounts are a good thing, but the bean-counters in government have imposed draconian limits on IRAs. These limits should be repealed. So-called "universal" IRAs would allow workers to save and invest as they see fit without being punished for being frugal.

Stop overtaxing businesses. Imagine if you were forced to overstate your income every April 15 so the government could collect more money. Sounds outrageous, but it's what American businesses have to do every year. Companies are supposed to be able to deduct all their expenses when calculating their taxable income, but the money spent on new investments has to be deducted over a period of years, even though the cost occurs right away. This provision of the tax code should be repealed so businesses can deduct costs as they occur.

Big spenders will complain that we can't afford a bigger tax cut, but they assume that your income belongs to the government. In reality, both the administration and the Congressional Budget Office estimate that the government will collect more than $3 trillion of extra tax revenue over the next 10 years -- a projection made after the Bush tax cut was enacted.

The real debate is what will happen to this money. Some argue that Washington politicians should be allowed to spend the money on pork-barrel projects, and special-interest groups have lined up at the Treasury door in hopes of getting their slice of the pie. This is what Europe's welfare states have done every time they got hold of some extra money, and the result is double-digit unemployment and economic stagnation.

The other alternative is returning the money to the private sector. Tax cuts and Social Security privatization would reduce the burden of government and increase incentives to work, save and invest. This, not tax-cut repeal, is an agenda that will boost America's competitiveness and ensure faster growth.

Lawmakers in Washington should choose growth over government -- and they should do it sooner rather than later.

Daniel Mitchell is the McKenna senior fellow in political economy at The Heritage Foundation, a Washington-based public policy research institute.

About the Author

Daniel J. Mitchell, Ph.D. McKenna Senior Fellow in Political Economy

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