108th Congress works its way to the end of its second
session, assessments of its likely place in the history of public
policy are beginning to be written. Certainly this Congress's
actions on the Medicare prescription drug benefit and its support
of the ongoing war on terrorism will loom large. However, the
future may unfold in a way that will emphasize another of this
Congress's contributions: its role in establishing the conditions
for a long period of economic prosperity.
If the significant
expansion of economic well-being is one of this Congress's enduring
legacies, that place in history will stem primarily from the
passage of the Jobs and Growth Tax
Relief Reconciliation Act (JGTRRA), which President George
W. Bush signed into law on May 27, 2003. That legislation is one of
the greatest supply-side changes to tax law in U.S. history. And
JGTRRA has delivered on its economic promise.
All across the economic spectrum, JGTRRA left
its tracks. For example, the unemployment rate peaked in June 2003
at 6.3 percent, began dropping in July, and has held steady at 5.6
percent-lower than the average unemployment rate in the 1970s,
1980s, and 1990s-for all but one month of 2004. The growth of GDP
accelerated sharply in the third quarter of 2003 after the tax cut
was enacted. Growth has remained high, averaging 5.4 percent per
year after JGGTRA, compared to a 1.8 percent annual rate over the
previous three and a half years.
Why would employment and production surge so
visibly? Incentives. JGTRRA accelerated the phase-in of incentives
to work and invest from the President's 2001 tax cuts, while also
providing major new incentives:
Lower tax rates on personal income for all taxpayers. The
top marginal tax rate was reduced from 39.6 percent to 35 percent,
and a 10-percent bracket was introduced.
Lower taxes on business investment, including a much lower
tax rate, 15 percent, on dividends and on long-term capital gains.
Equally important, JGTRRA allowed businesses to more quickly deduct
the expenses of their investments in machinery, computers, and
An increased child tax credit, from $500 to $1,000 per
The end of the marriage penalty. Married couples no longer
pay higher taxes than equivalent singles, which eliminates a
perverse incentive against marriage.
A phased-in repeal of the estate tax.
While it will be
some time before economists have enough data to make precise
estimates of JGTRRA's contributions to economic activity, current
data strongly imply that the legislation had much to do with the
timing of economic take-off. American companies responded to the
2003 tax cuts by employing more workers and more capital equipment
beginning almost the moment lower taxes became law.
The impact of JGGTRA
is summarized in Table 1. In the fourteen quarters before the 2003
tax cut, growth averaged 1.81 percent, annualized, compared to 5.4
percent during the three quarters after its passage. Total
investment contracted at a rate of 1.14 percent, annualized, before
the 2003 tax cut, and grew at a 13.03 percent rate after. The Dow
Jones Industrial Average contracted four-tenths a percent per month
before the cut, but grew 1.11 percent monthly on average after
JGGTRA. Consumer sentiment grew at similar rates, getting a huge
boost after JGGTRA passed. The biggest impact, though, has been on
jobs, which grew at a paltry 18,000 per month for three and a half
years before JGGTRA, and then surged to 143,000 per month
output grew by an amazing 8.2 percent, at an annualized rate, in
the third quarter of 2004, as shown in Chart 1. What accelerated
GDP growth in the short term was increased business investment
(known as "non-residential fixed investment"), as shown in Chart
Growth in business
investment fell sharply in the summer of 2000, from an annualized
rate of 14.8 percent in the second quarter to 2.2 percent in the
third. Business investment dropped still further in the fourth
quarter of that year and then declined for the next nine quarters.
Non-residential fixed investment responded strongly to the
reductions in taxation on capital in JGTRRA. Business investment
grew 7 percent in the second quarter of 2003 and has increased in
every quarter since the enactment of the bill.
unexpectedly floundered for more than a year in 2002, even as most
forecasters anticipated a take-off. Uncertain expectations surely
played a role, affirming that the non-rational elements (e.g.,
moods, opinions, preferences for risk) play a large role in the
economy. However, a change in attitude is powerfully evident after
the summer of 2003: the Dow Jones Industrial Average roared past
the 10,000 mark, consumer sentiment returned to pre-recession
levels, and total employment reached record highs. Charts 3-5 show
how these three measures, which tell a great deal about consumer
and business confidence, responded to JGTRRA.
The payroll survey
is only one measure of job creation, and the last three years have
revealed that it is incomplete. A job growth gap of over two
million exists between payroll employment and total U.S. employment
(as measured by the Labor Department's Survey of Households).
Partisans tend to focus exclusively on the payroll numbers without
addressing its documented inability to measure self-employment and
its currently depressed double counting of turnover.
The key figure in
assessing the job market, however, is the rate of employment in the
overall labor force. The rate of unemployment stands at 5.6 percent
today. In other words, 19 out of 20 Americans who are willing and
able to work are employed, and economic theory and practice tell us
this is about as low as the unemployment rate can get because of
transitional and structural unemployment.
Critics say that
the unemployment rate is flawed because it ignores discouraged
workers, pointing not to the number of discouraged workers, which
has been steady since the 1990s, but to the proportion of the
population that is employed, which is below what it was at the peak
of the dot-com boom. But data show that two-thirds of the decline
in this measure is due to teens choosing not to enter the workforce
in unprecedented numbers. Demographics, not economics, drives the
ratio of employment to population. The bottom line is that the
unemployment rate peaked the month before the 2003 tax cuts and is
now both stable and below the average rate of the 1990s.
The Long-Term Economic Effects of
data confirm that JGTRRA made a major difference to today's
economy, and additional data will no doubt further underscore the
In April of 2003,
the Heritage Foundation's Center for Data Analysis used one of the
most respected and widely employed models of the U.S. economy to
forecast the effect of the proposed version of JGTRRA on hundreds
of major economic indicators. CDA's forecasts of one
year ago have, so far, proved mostly accurate.
non-residential fixed investment, and the S&P 500 were all
stronger than the baseline models projected for 2003 and the first
half of 2004, as predicted. CDA's biggest forecasting error was in
employment, which did grow in the latter half of 2003, but slower
For 2004, CDA
projected almost one million more jobs over the baseline employment
growth of two million. The economy has added 1.3 million payroll
jobs through the first six months of 2004 and even more non-payroll
jobs. The economy appears to be on pace to meet CDA's prediction of
three million new jobs in total for the year.
Charts 6 through 9
compare CDA's April 2003 forecast of JGGTRA's impact, the CBO's
baseline forecasts, and the actual economic performance of selected
indicators during 2003 and the first half of 2004.
CDA forecasts can
be used to estimate the impact of the 2003 tax cut over the next
five years. GDP should grow, on average, by almost $70 billion per
year above baseline. Consumption expenditures should be almost 1
percent, or $69 billion, more per year that without the tax cuts.
Non-residential fixed investment should grow strongly at over $50
billion a year, or over 3 percent. The S&P should continue to
climb and reach 1840 by the end of 2008.
We anticipate the
long-term effects of JGGTRA will be even stronger than the
short-term stimulus. The supply side of the economy has new
incentives to expand, to work, to save, and to invest.
JGGTRA was an
important step forward in organizing federal taxes in a manner that
optimizes growth for all Americans by establishing incentives to
work and invest. Fast, steady increases in employment and
investment led increases in other indicators almost immediately
upon the Act's implementation in July 2003.
benefit to supply-side policy, however, is in the long-term
dynamics, and so patience will be required before we can fully
assess the impact of JGGTRA.
bear repeating, however. First, economic theory and experience tell
us that permanent changes in policy have a larger impact on
behavior than temporary stimuli. Reducing taxes on capital has wide
support, including the strong backing of Federal Reserve Chairman
Alan Greenspan, as the key to accelerating long-run growth. JGGTRA
was a historic achievement in this regard. But the best elements of
JGGTRA must be made permanent in order to be fully effective in
promoting growth. Second, JGGTRA is a far cry from fundamental tax
reform. An optimal pro-growth tax system would be much simpler and
treat all Americans equally, without the chaotic unfairness of
countless special interest deductions and credits that plague the
Bill Beach is
Director, Rea Hederman is Manager, and Tim Kane is Research Fellow,
of the Center for Data Analysis at The Heritage Foundation.