November 8, 2005

November 8, 2005 | Commentary on Taxes

Cut Spending to Save Needed Tax Cuts

Second in a Series

 

If you say, "I have good news and bad news," people usually ask for the good news first. So here's the good news: Our economy is growing, easily outpacing the tepid performance of other industrialized nations.

 

Unemployment, according to the Labor Department payroll survey, holds low and steady near 5 percent. Even Hurricane Katrina, which shut entire industries for a month, drove up the unemployment rate only by a miniscule .02 percentage point.

 

The economy is hovering near what economists call full employment, where most everyone who wants a job can get one.

 

Over the last year, 2.2 million new payroll jobs have been created. Add in farm employment and net job creation totals 2.4 million. The United States has more workers than ever, remarkably low unemployment and low inflation.

 

Hold the Line

 

What explains this superior economic performance? Excellent tax policy plays a large part. Since President Bush took office in 2001, the government has cut taxes three times. And the most recent round included true "supply side" cuts such as marginal tax rate reductions and lower tax rates on dividends and capital gains -- the ones that actually generate greater economic growth.

 

Almost everyone is enjoying lower tax rates, so there's more incentive for people and companies to save and invest. It's no mere coincidence that five million more Americans were employed in August 2005 than in May 2003, when the latest round of tax cuts took effect.

 

Now the bad news: Unless Congress gets spending under control, these tax cuts -- and the economic growth we now take for granted -- will vanish.

 

Here's the problem: The federal government is about 33 percent larger today than it was in 2001 and spends some $22,000 per household. And regardless of how this spending is financed, either with taxes or borrowing, the economy will suffer since resources will be transferred from the productive sector to the government.

 

Twice as High

 

Some of our political leaders are in denial. A recent memo by a senior economic aide to Senate Majority Leader Bill Frist claimed we were actually in good economic shape, since "no other industrial nation's centralized government spends less than the United States measured as a share of their economy."

 

Alas, "We're in better shape than France and Germany" isn't much of a reason to brag. And even that modest boast won't last long. If we don't make changes, Social Security, Medicare and Medicaid obligations will push U.S. government spending to western European levels in just one generation.

 

Such spendthrift ways, unchecked, will have severe consequences. Today's tax rates would have to double to cover Washington's promised entitlements.

 

A taxpayer now in the 25 percent tax bracket would face a marginal tax rate of more than 50 percent, while a taxpayer now paying the top rate of 35 percent would get bumped to a 70 percent tax rate -- a confiscatory rate even the French government would be reluctant to impose!

 

Such European-level taxation would bring European-level jobless numbers. France's unemployment rate last year was 10.1 percent -- double ours. Germany came in at 10.6 percent. There's little doubt the same thing would happen here if we doubled tax rates.

 

The burden of government is already heavier than some suspect. Total spending by U.S. governments -- federal, state and local -- reached 35.9 percent of GDP in 2005. That's more than Australia (35.5 percent), Ireland (35.2 percent) and New Zealand (35.1 percent).

 

Those countries should be our long-term models. After all, Australia's unemployment rate last year was 5.1 percent, while Ireland was at 4.3 percent and New Zealand an amazing 4.2 percent. Less spending means fewer taxes and lower unemployment.

 

Extended Too Far

 

The real lesson to learn from this is the need to control both discretionary spending and entitlement spending. Heritage Foundation economic models predict that making the Bush tax cuts permanent would create 430,000 additional jobs nationally in 2006 and an average of 624,000 per year over the next decade. That's tremendous growth, but it can happen only if we bring spending down.

 

Sadly, there's still more bad news. Next week we'll take a closer look at the commitments Washington is making through its generous entitlement programs -- commitments we can't possibly afford to keep.


Ed Feulner is president of The Heritage Foundation (heritage.org), a Washington-based public policy research institute.

About the Author

Edwin J. Feulner, Ph.D. Founder, Chairman of the Asian Studies Center, and Chung Ju-yung Fellow
Founder's Office

First appeared in Investor's Business Daily