April 7, 2006

April 7, 2006 | Commentary on Taxes

Avoiding tax hikes

Going to work. It's a daily routine for most Americans.

But suppose one day your boss suddenly announces the office is moving. He can't say where or when, though. Oh, and work hours would be changing, too. But what those hours will be, he couldn't say.

You can imagine how most people would react. They'd probably start updating their resumes.

Of course, no sane business would operate in such an unpredictable fashion. But when it comes to tax policy, the federal government does. And since tax policy affects the bottom line for all of us, we should ask why.

In 2003, President Bush and Congress collaborated on common-sense tax relief. They reduced the tax rates on capital gains and dividend income. The plan worked.

In the last three years, these lower rates have spurred the economy by encouraging entrepreneurs to invest and by prompting companies to increase divĀ­idend payments to stockholders. Both steps helped boost the stock market, which had been lagging since 9/11. The Dow is now growing steadily, passing 11,000 for the first time in several years. Our economy has created millions of new jobs, and people have more incentive to save and invest.

But between now and January 2009 (less than three years from now) most of the 2003 tax reforms are scheduled to expire. Most of the 2001 tax cuts will expire just two years later, in January 2011. Unless lawmakers act, rates will rise substantially. This would mean higher taxes on American families.

Investors and entrepreneurs are watching closely to see if lawmakers will extend the lower taxes on dividends and capital gains -- taxes set to increase as early as January 2009. There are two main reasons to lock in all the lower rates.

For one thing, doing so would boost the economy.

A computer model at The Heritage Foundation's Center for Data Analysis predicts what would happen if we made the lower rates permanent:

  • The economy will add an average of 1 million jobs each year.
  • Personal savings will increase by an average of $163 billion each year after inflation.
  • Average after-tax household income would soar by an annual average of $274 billion per year after inflation.
O n the other hand, if Congress fails to make the 2001 and 2003 tax cuts permanent, we'll actually suffer large tax increases. Our model predicts the economy would shed more than 1 million jobs each year between 2011 and 2014. We'd lose more than $100 billion in economic output per year and suffer slower wage and salary growth and slower savings growth. America simply can't afford that.

The other reason to make the cuts permanent is because our political system functions better when there's predictability. Just as Americans need to know where they're going to work each day, they need to know that there will not be a sudden tax increase on their earnings and investments in the years ahead.

Consider just one tax, the death tax. It's set to dwindle to 0 percent in 2010, and then come back, zombie-like, at a whopping 55 percent the following year. Liberal economist Paul Krugman calls that a "throw Momma from the train" provision because, perversely enough, it give heirs a strong incentive to pull the plug in 2010. That needs to be fixed. Lawmakers should make death-tax repeal permanent.

It's much harder for businesses, investors and individuals to plan for the future with the specter of potential tax hikes casting a shadow. That's why Congress needs to act soon to lock in the 2001 and 2003 tax cuts and reassure everyone that tax rates aren't set to soar again. That way, we'll all be sure that America, Inc. is permanently heading in the right direction.

Edwin Feulner is president of The Heritage Foundation (heritage.org), a Washington-based public policy research institute and co-author of the new book Getting America Right.

About the Author

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

Related Issues: Taxes