Posted on 01/09/2003 6:48:14 AM PST by xsysmgr
It is amazing how little the pundits understand President Bush’s economic views.
Just a few days ago editorials referring to the Bush economic plan were speculating as to what the plan would and would not include. The editorials were almost in unanimous agreement that the president would have to “soften” his stimulus package. The softening options included paring back the planned elimination of the double taxation of dividends to 50%. Another possibility was to drop the plan to accelerate marginal rate cuts for higher earners. .
Yet to the surprise — and perhaps disappointment — of many pundits, the president went beyond what was originally expected. He proposed a larger program, with deeper cuts focused on individual rate cuts.
How could the pundits have it so wrong? They were using a Keynesian framework instead of a supply-side framework.
Within the textbook Keynesian model government spending and tax revenues are two sides of the same coin. One increases aggregate demand and the other reduces it. Hence, reductions in spending and/or revenue enhancements are equally attractive ways to reduce the deficit. The revenue impact of the tax is all that is needed to determine its impact on the economy through its aggregate-demand effects. It doesn't matter whether the tax rate is temporary or permanent — only the magnitude matters.
This is quite important. If no allowance is made for the disincentive effect of higher tax rates, the effect of the rate change on the tax base is assumed to be nonexistent. That's a static revenue estimate.
The simple Keynesian framework also does not take into account government budget constraints. Deficit financing implies future tax liabilities; a forward-looking taxpayer would anticipate the future taxes and that would negate the aggregate-demand effects that the Keynesian claims the deficit financing generates.
Supply-siders counter that there is no income effect once one takes into account the government budget constraint. All that remain are the substitution effects, or incentive effects, that the Keynesians ignore.
Unlike the Keynesians — who focus almost exclusively on the income effect of the tax cuts — the president focused on the incentives that his program would generate. Regarding the budget deficit he argued that what we have is a temporary revenue shortfall. He also offered a solution to the problem: growth, not higher taxes. While remaining true to his argument for a smaller government, he argued the need for (hopefully) temporary higher spending. And on the role of government, he was crystal clear:
Government spends a lot of money, but it doesn't build factories, it doesn't invest in companies, or do the work that makes the economy go. The role of government is not to manage or control the economy from Washington, D.C., but to remove obstacles standing in the way for faster economic growth. That's our role.Bush also understands the disincentive effects of higher tax rates and higher regulation:
Many jobs are lost in America because government imposes unreasonable regulations, and many jobs are lost because the lawsuit culture of this country imposes unreasonable costs. . . . I will continue to press for legal and regulatory reform. But today — today I want to talk about these concerns: Americans carry a heavy burden of taxes and debt that could slow consumer spending. I'm troubled by that. I'm also troubled by the fact that our tax system unfairly penalizes some productive investments.If that is not focusing on incentives, what is? The case for lower tax rates was clear in the president’s mind. In order to avoid a slowdown generated by the transition effects of prospective rate cuts, Bush asked for the cuts to be enacted retroactively to the beginning of the year:
If tax relief is good enough for Americans three years from now, it is good enough for Americans today.Indeed, the president sees no need for uncertainty about taxes:
Americans should be able to count on those tax cuts as they plan their financial futures. So I will continue to press the Congress to make these cuts, including the end of the death tax, permanent. We know that tax cuts [work], and Americans deserve to know their cuts will not be taken away.Finally, in summarizing his economic package, George W. Bush correctly focused on growth and incentives rather than income and redistribution:
This growth and jobs package is essential in the short run; it's an immediate boost to the economy. And these proposals will help stimulate investment and put more people back to work. . . . They are essential for the long run, as well — to lay the groundwork for future growth and future prosperity. That growth will bring the added benefit of higher revenues for the government — revenues that will keep tax rates low, while fulfilling key obligations and protecting programs such as Medicare and Social Security.Spoken like a true supply-sider, Mr. President.
By eliminating the personal income tax paid on corporate dividends, the plan effectively provides investors with an incentive to shy away from more risky investments that might produce long-term growth and encourages them to invest in income-producing stocks. One of the things that made the late 1990s such a strong period for capital-growth investments such as real estate and growth stocks was that there was a wide spread between the top tax rate paid on income (38%) and the top rate paid on capital gains (20%).
What the Bush plan essentially does is reduce some of the volatility in the stock market. This may seem like a good thing, but making the stock market more closely resemble the bond market is hardly a "supply-side" principle.
In a true "supply-side" environment, the tax code should always be structured so that an investor with $100,000 in his pocket is encouraged to start or invest in a new business instead of buying General Motors or Exxon/Mobil stock.
This is where Keynesians get it exactly wrong. First, there is a substantial waste effect every time a dollar flows through the Federal Government. I suspect that at least 40% of money that flows through the Feds is essentially burnt on the bureaucratic pyre.
Second, taxes take money from productive purposes. There is a positive future value of money reflected in the rates of return one can earn on investments (say 10% for argument's sake). These actual investments are foregone when the cash is sucked in by the Feds.
So, the net effect of Federal Tax and Spend policy is a NEGATIVE 50% return using my estimates above.
The converse is precisely true. Stop the sucking of money by the Feds, leave it in the productive sector, and the return to the economy increases by that same 50%.
The benefits above happen even before you take into account the behavioral effects of lower tax rates. High tax rate payers slack off. When their tax rates are lowered, they work harder. Since these are the economy's most productive people, we're talking about a huge multiplier effect for the businesses they start, the people that they hire, and the additional productive use of capital in the country.
Keynesians are the "Flat-Earthers" of the economics world. There are virtually no conscious economists who believe that voodoo any more.
I would agree under ordinary circumstances. But, and I'm not privy to this information, suppose the issue here is to get people into the market in general. I mean, suppose that people have been so turned off from the market that they aren't willing to take anything but the smallest risk. What better way to get back into stocks than to get into ones that pay dividends.
I don't know if I said that right; my take is that if people have shyed away from stocks over the last year or two, the only way to get them over that fear is to provide an investment with less risk and some up-front payback. Thus, the dividend.
The Enron debacle was a good example. Go back and remember all those sob stories about Enron employees who lost all of their retirement funds because they were so heavily invested in Enron stock. Even a mediocre financial advisor would never recommend having more than 10% of your portfolio in a single stock, esepecially if you are already "investing" your time and resources in the company by working there.
This is not the time to start holding people's hands when it comes to investing. Anyone who isn't willing to take the risks of stock market investing should be investing in something else.
"A bear market is a time when stocks are returned to their rightful owners." -- Wall Street adage
There is another effect when a dollar goes through the FedGov. The people spending it have no incentive to spend it efficiently. Money goes to inefficient investments and that hurts the ecomony overall.
Well, "get them into the market" in the sense of reducing a reason for them to stay out.
People keep attacking the dividend thing as though Bush was setting a dividend scale that corporations must pay out.
That is part of the problem - the shoe-shine kid giving stock tips is a clue as to when to get out. But the other side of that coin is the mutual funds as used in a 401K. One would expect that such funds are run by people that have a clue and for the most part, they are correct. But, even the best investor cannot escape the overall market fluctuations that naturally occur.
Unfortunately, many people have gotten out, and often at the worst time possible, due to fear, not understanding that a weak market is a buying opportunity, not a selling opportunity (I'm speaking in generalizations here; its often wise to sell a dog before it dies). They are now scared to invest, and they are thus losing out on the best opportunity for long-term growth. For those people, the dividend may be the only way they'll enter the market.
There are some advantages to having a majority of Americans invested; for one thing, people are much less likely to support socialist programs when they "own a piece of the rock", so to speak.
The Enron debacle was a good example. Go back and remember all those sob stories about Enron employees who lost all of their retirement funds because they were so heavily invested in Enron stock. Even a mediocre financial advisor would never recommend having more than 10% of your portfolio in a single stock, esepecially if you are already "investing" your time and resources in the company by working there.
Darwin has a way of rewarding bad investment decisions. But, do remember that not all of those people that complained were putting their own 401k money into Enron stock. Enron, like many corporations, had a stipulation that the company matching portion of their investment (in other words, the free money that they would not otherwise get if they weren't in the 401 plan) had to be in Enron stock. To the extent that this happened, people were complaining about money that was essentially a gift. I do agree with your premise though that one should not put all eggs in one basket (or even a large proportion of ones' eggs), particularly when that basket provides their only wage income.
This is not the time to start holding people's hands when it comes to investing. Anyone who isn't willing to take the risks of stock market investing should be investing in something else.
I don't consider policy that promotes dividend payment to be 'hand holding'. Its providing for an investment opportunity (I hate that phrase, but it is applicable here) for people whose risk-taking propensity falls somewhere between bonds and growth stocks. Besides, the dividends really shouldn't be double-taxed anyways.
(As an aside, I don't consider this policy as promoting dividends so much as I see it as removing an unnecessary restriction on dividends).
"A bear market is a time when stocks are returned to their rightful owners." -- Wall Street adage
I like that! And, I guess I've become the rightful owner of a little tiny slice of something. :^)
This was the poison pill in the Reagan tax cuts. The recession of 1982 was exacerbated by the anticipation of lower rates on January 1, 1983. Like magic, the Reagan tax rate cuts began to work--but not until they actually started!
I well remember Paul Harvey, starting his early-morning broadcast of October 1, 1981 (the day the measly "first installment" of the Reagan tax cut started): "The Reagan tax cut has been in effect for six hours. Speaker of the House James Wright says..........it isn't working!"
Exactly - remove the unnecessary restrictions.
People keep attacking the dividend thing as though Bush was setting a dividend scale that corporations must pay out.
That is correct - most companies will still not pay a dividend. There is no stipulation to do so, and this policy won't create a situation that makes dividend payout that much more lucrative for a company. A few may consider it if it helps raise stock prices when they want to raise capital, but I don't see an avalanche. Generally, more mature industries pay dividends while upstarts and high-growth companies will not. That is as it should be - The local electric company probably isn't going to grow much, but that shouldn't make their stock worthless - they still need to raise capital from time to time.
In other words, by making "growth stocks" artificially attractive, the tax code subsidized a stock bubble. Did us all a lot of good!
The double-taxation is clearly the best case to be made in favor of the elimination of the dividend tax. My only quesion is this -- Would it be better to keep the income tax paid by the shareholder but eliminate it on the corporate end?
Look at it this way. Suppose a manufacturer generates a real profit of $40 million -- Would the overall impact on the economy be greater if the profit were paid out in dividends, or if the $40 million were spent opening a new plant or starting a new product line? All other things being equal, supply-side economic theory definitely favors the latter.
If GM or Joe save rather than spend, it goes into a bank who loans it to a company wanting to grow anyway. The only way giving money back to the private sector instead of keeping it in government can backfire is if the recipient elects to keep the cash in his mattress. Any other use is preferable to govt. confiscation. Before the term was discredited this used to be called "Trickle Down", the meaning being that even though Joe or GM didn't buy a flamingo for their lawn Joe put the money in the bank, the bank loaned it to fred to start a business, Fred hired a clerk and the clerk bought a flamingo for his lawn.
By your own admission, part of what made the 90's a growth period was the difference between the 20% dividend tax rate and the 33% income tax rate, if this is so how can lowering the dividend rate thereby increasing the difference between the two rates not be a larger stimulus.
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