Wednesday, March 15, 2006

Tax cuts and revenue hikes

Commentary by David Reinhard


David Reinhard

Sen. Gordon Smith had his work cut out for him. Addressing the 42nd Dorchester Conference last weekend, the Oregon Republican said he had come to Seaside (Ore.) to buck up the Republican throng.

President Bush's sagging poll numbers, the Dubai ports deal, Jack Abramoff, the upcoming congressional elections -- now why would he want to do that?

And would anything less than handing out Prozac do the job?

It was an approach I initially thought that Smith might take when he announced that he wanted to talk about "the pursuit of happiness," but then the senator got back to GOP basics:

Tax cuts and the economy.

Instead of anti-depressants, Smith came armed with figures he said the audience wouldn't find in most media reports. Since 2003, the U.S. economy has created 4.7 million new jobs, 2 million in the last year alone, and 200,000 in January. Americans have created more jobs than the European Union and Japan combined. Despite the bursting of the stock market bubble and 9/11, despite Enron scandals and Katrina, we've had solid economic growth for 55 straight months.

"Freedom works," Smith says. "It's even filling government coffers."

Smith is an unapologetic tax-cutter. He always has been, and doubtless always will be after contemplating the revenue-raising results of Bush's 2003 cuts in capital gains taxes. Recent figures from the Congressional Budget Office will only bolster this Senate Finance Committee member's view that the Bush tax cuts should be made permanent.

Three years ago, Bush and Congress cut rates on capital gains taxes to 15 percent. At that time, the Joint Committee on Taxation estimated that the lower rate would cost the government $3 billion from 2003 through 2005. Specifically, the capital gains tax collections were predicted to come in at $138 billion in those fiscal years. Those were the estimates.

Now, we have real numbers, hard data, actual revenue figures. The guesswork is done. According to the American Shareholders Association analysis of the most recent Congressional Budget Office data, the capital gain tax collections for the 2003, 2004 and 2005 fiscal years totaled $185 billion. That is, the federal government collected $47 billion more than the Joint Committee on Taxation estimated after cutting the capital gains rate from 20 percent to 15 percent.

So, instead of costing the federal government $3 billion, the cut in the capital gains tax rate made the government $47 billion. If you run the numbers for the calendar years, the government's take is even larger: $62 billion.

Whatever way you count it, this particular supply-side tax cut paid for itself many times over.

The American Shareholders Association's Daniel Clifton predicted just this a while ago, but he's hardly prepared to claim special powers of prophecy.

"This should come as no surprise since the same effect occurred following the 1981 and 1997 capital gains tax reductions," he says. "Following the 1997 capital gains tax cut, revenues increased $24 billion above the forecast in 1998 and $36 billion above forecast in 1999 due to higher levels of economic growth and shareholder wealth."

This cut did then, and is doing today, everything its champions promised. The reduction in the capital gains rate prompted investors to cash out of old investments they were staying in to avoid taxes and reinvest in more productive assets. This is the so-called "unlocking effect." The change also increased stock values and shareholder wealth by boosting the after-tax return on capital and making equities more appealing compared to other investments. Finally, the capital gains tax cut spurred business creation and higher levels of economic growth.

Again, as Smith said last weekend, "Freedom works. It's even filling government coffers."

Come to think of it, cancel the anti-depressants. The best way to boost moods and the U.S. economy may be for Smith to get back to Washington and do everything he can to make this tax revenue-raising cut permanent.

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