The Magazine

A Little Modesty, Please

Bush's tax cut didn't cause the economic recovery.

Apr 8, 2002, Vol. 7, No. 29 • By STEPHEN MOORE
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FEELING BUOYANT and mighty relieved by the stream of good news on the economy for the first quarter of this year, the Bush administration refuses to leave well enough alone. The White House has been issuing triumphant press releases about how the president is responsible for this apparent recovery. President Bush's Council of Economic Advisers has boasted that the Bush tax cut expanded economic output in the second half of 2001 by nearly a full percentage point and "helped put the economy back on the road to recovery in 2002."

More cheerleading came on March 13, when Harvard economist Martin Feldstein touted the Bush tax relief plan in a Wall Street Journal article entitled, "Tax Cuts, Rate Cuts Put the Economy Back on Track." Feldstein argued that the tax plan has already had "expansionary effects" by providing "a substantial lift to demand" and a "greater stimulus to spend."

Unfortunately, these statements are only slightly more persuasive than when Tom Daschle blamed the Bush tax cut for the recession. One inconvenient fact that made Daschle's anti-tax cut rant so preposterous--as several of us economic pundits quickly noted--was that there hasn't been a tax cut yet to speak of. Sure, there were the $300-$600 tax rebate checks sent out to workers late last summer. But this could only have helped if the Keynesian model of consumer demand as the driving force behind the economy were correct. And it isn't. If rebate checks can elevate growth rates, then we should get the government to send out $1,000 or even $2,000 rebate checks every August.

Moreover, even if one accepts the discredited Keynesian consumer-demand idea--as many in the White House evidently do--the evidence from this past fall indicates that most of the rebate dollars were not spent at all, they were stashed away in the bank and saved. So how could they have unleashed a recovery?

The White House seems befuddled about its own tax cut. The main economic value of tax cuts is to reward productive behavior--and by that I don't mean rushing off with the credit card to Wal-Mart (or Neiman Marcus, for that matter) and filling the shopping cart. Economic growth is not driven by big spending consumers but by individuals engaging in acts of enterprise: investment, risk-taking, work, and deferred gratification. High tax rates penalize these activities. But a tax rebate has almost zero impact on reducing barriers to growth or reducing capital costs.

Feldstein and the Bush economists are correct that the Bush tax cut will be a modest plus for the economy over the long term. But the operative word here is "long term." The only supply-side tax cut that has so far taken effect in the Bush plan is a 1 percentage point reduction in the top income tax rate from 39.6 percent to 38.6 percent. In fairness to Bush, this was about the best deal he could cut with the Democrats in Congress, who are as enthusiastic about tax cuts as my dog is about our electric fence. This reduction isn't inconsequential, but it certainly doesn't explain how the economy went from negative growth to perhaps as much as 4 percent growth so far this year. And I write this as someone who favored the Bush tax cut.

Another argument put forward for how the tax cuts are helping the economy is the notion that the promise of the future income tax rate cuts is positively impacting business and consumer behavior today. But phasing in tax rate reductions in the future delays economic activity, it doesn't accelerate it. Who in their right mind buys a car today, when they know that the big sale starts next week?

In sum, tax policy changes have had little to do with the nation's improved economic performance. We are experiencing the early stages of a mini-recovery that has been inspired almost entirely by monetary policy corrections. The Fed's belated interest rate cuts last year are finally beginning to revive business conditions. Whether the Fed rate cuts can on their own pull the economy back onto anything like the path of nearly 5 percent real GDP growth that we saw in the late 1990s is anyone's guess.

The problem with the administration's tax cut hyperbole is that overstating the impact of minor tax cuts could shatter Republicans' credibility--and undermine the intellectual case for supply-side tax rate reductions altogether. It's a little soon to be celebrating a return to the Roaring Nineties. The economy is hardly out of the woods, especially given the shakiness of the global economic situation. If this slight burst of prosperity stalls or turns into a double dip recession, the Bush team will have to eat its words, and the Daschle crowd will emcee the event: See, we told you so. Tax cuts don't work.

Every administration wants to toot its own horn when times are good. But there are more and less intelligent ways of doing so. Overselling the tax cut is yet another sign that this White House is incoherent in its economic thinking. Earlier this year the president bizarrely described his administration's philosophy as "part Keynesian, part supply side." That's a little like being part carnivore, part vegan. In any case, the Keynesian part seems to be dominant. Just one example: After September 11, a capital gains tax cut as part of an economic stimulus plan was well within the administration's reach. The White House economic team not only shunned the idea but made fatuous arguments that this might depress the stock market. It would have had precisely the opposite impact.

The White House does actually have a compelling story to tell about how the president's policies have helped restore economic growth. But it's not a story about the puny tax cut. No, it's his masterful handling of the war. Markets abhor risk, uncertainty, and threats to global commerce. Confidence in Bush's war leadership has reduced the investment risk premium associated with the grave new threat of terrorism. One of the underappreciated causes of the explosive economic recovery in the 1980s was Reagan's unwavering commitment to defeating the Evil Empire. Similarly, the investment climate has turned bullish--at least for now--largely because the investor class in America trusts Bush to contain and defeat the forces of terrorism around the globe.

That investment climate would turn a whole lot more bullish if the Bush tax rate cuts were made effective immediately (not in five years) and made permanent (they're now set to expire in 2011). Republicans should keep up the fight for this common sense stimulus policy. That won't happen until the White House stops congratulating itself for the wrong things.

Stephen Moore is a senior fellow in economics at the Cato Institute.