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May 31, 2006

Strong growth of economy no coincidence

By

Almost lost in the clamor over illegal immigration, Americans got some good economic news last week when President Bush signed legislation that will extend the 15 percent tax rate on dividends and capital gains through 2010.

It would have been even better to simply make these cuts permanent, but a two-year extension is a good start. Ever since the cuts were enacted in 2003, the economy has performed remarkably well. Growth and job creation both have been especially strong.

For instance, inflation-adjusted economic output (real gross domestic product) has jumped by about 3.5 percent annually ever since the 15 percent rate on dividends and capital gains was enacted. This is particularly impressive since growth fell to anemic levels during the last two quarters of the Clinton administration, remained low in 2001 and improved only modestly in 2002.

Also, job creation skyrocketed once the double taxation of dividends and capital gains was reduced. More than 6 million jobs have been created since the beginning of 2003. The unemployment rate, not surprisingly, has fallen dramatically. After peaking at 6.3 percent in mid-2003, it is now 4.7 percent.

Opponents argue, of course, that the robust economy is a coincidence, but this argument does not explain why the United States is performing so much better than other industrialized nations.

Whether measured by economic growth rates, job creation, productivity, wealth creation, financial markets or unemployment, the United States is easily out-performing nations such as Germany, France and Japan. Indeed, per-capita GDP in the United States is about 40 percent higher than it is in the European Union.

Meanwhile, the 2003 tax cuts have generated a huge "supply-side" response. Strong economic growth means people have more income, and more income means a larger tax base.

And even though - or perhaps because - tax rates are lower, the government is collecting a lot of additional money. Revenues have been pouring into the treasury at record rates. In the past 12 months, tax receipts have skyrocketed 14.5 percent, more than four times faster than inflation. And in the previous 12 months, they jumped nearly 9 percent, almost three times faster than inflation.

It is especially worth noting that the government is collecting more money from capital-gains taxes and dividend taxes. As The Wall Street Journal noted, "Capital-gains receipts from 2002-04 have climbed by 79 percent after the reduction in the tax rate from 20 to 15 percent. Dividend tax receipts are up 35 percent from 2002 to 2004, even though the taxable rate fell from 39.6 to 15 percent."

This does not mean that tax cuts necessarily "pay for themselves," but it does mean that the right kind of tax policy - one that lowers tax rates on work, saving and investment - will lead to faster economic growth. And faster economic growth means more income for the government to tax.

The ideal public policy is a 0 percent tax rate on dividends and capital gains, and we may eventually get there. Meanwhile, a permanently reduced rate of taxation is the second-best option, which is why the temporarily extended 15 percent rate is a step down the right road.

Daniel J. Mitchell is the McKenna senior fellow in Political Economy at The Heritage Foundation.

First appeared in the Des Moines Register

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