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Real Tax Cuts Have Curves
The economy booms, and Arthur Laffer has the last laugh.

Sunday, June 19, 2005 12:01 a.m.


As legend has it, the famous Laffer Curve was first drawn by economist Arthur Laffer in 1974 on a cocktail napkin during a small dinner meeting at the Washington Hotel attended by the late Wall Street Journal editor Robert Bartley and such high-powered policy makers as Dick Cheney and Donald Rumsfeld. The Laffer Curve helped launch the Reaganomics Revolution here at home and a frenzy of tax-rate cutting around the globe that continues to this day.

Laffer CurveThe theory is really one of the simplest concepts in economics. Yet its logic continues to elude the class-warfare lobby, whose disbelief is unburdened by the multiple real-life examples that validate its conclusions. The idea is that lowering the tax rate on production, work, investment and risk-taking will spur more of these activities and thereby will often lead to more tax revenue collections for the government rather than less.

In the 1980s, President Ronald Reagan chopped the highest personal income tax rate from the confiscatory 70% rate that he inherited when he entered office to 28% when he left office and the resulting economic burst caused federal tax receipts to almost precisely double: from $517 billion to $1,032 billion.

Now we have overpowering confirming evidence from the Bush tax cuts of May 2003. The jewel of the Bush economic plan was the reduction in tax rates on dividends from 39.6% to 15% and on capital gains from 20% to 15%. These sharp cuts in the double tax on capital investment were intended to reverse the 2000-01 stock market crash, which had liquidated some $6 trillion in American household wealth, and to inspire a revival in business capital investment, which had also collapsed during the recession. The tax cuts were narrowly enacted despite the usual indignant primal screams from the greed and envy lobby about "tax cuts for the super rich."

Earlier this month the Congressional Budget Office released its latest report on tax revenue collections. The numbers are an eye-popping vindication of the Laffer Curve and the Bush tax cut's real economic value. Federal tax revenues surged in the first eight months of this fiscal year by $187 billion. This represents a 15.4% rise in federal tax receipts over 2004. Individual and corporate income tax receipts have exploded like a cap let off a geyser, up 30% in the two years since the tax cut. Once again, tax rate cuts have created a virtuous chain reaction of higher economic growth, more jobs, higher corporate profits, and finally more tax receipts.

This Laffer Curve effect has also created a revenue windfall for states and cities. As the economic expansion has plowed forward, and in some regions of the country accelerated, state tax receipts have climbed 7.5% this year already. Perhaps the most remarkable story from around the nation comes from the perpetually indebted New York City, which suddenly finds itself more than $3 billion in surplus thanks to an unexpected gush in revenues. Many of President Bush's critics foolishly predicted that states and localities would be victims of the Bush tax cut gamble.

Alas, all of the fiscal news is not celebratory. The CBO also reports that federal expenditures are up $110 billion, or 7.2%, so far this year as the congressional Republican spending spree rolls on. Nonetheless, it now appears that the budget deficit will be at least $60 billion lower than last year and states and cities, led by California, which a few years ago were awash in debt themselves, will enjoy net surpluses of at least $50 billion. This means that total government borrowing will come in at below 2.5% of national output, which is hardly a crisis level of debt. Many of the opponents of the tax cut maintained that they would push up interest rates, but today long-term rates are so low that we have seen in recent weeks a string of nonsensical warnings from confused economists about the supposed curse of low long-term borrowing costs.

On the private-sector side of the ledger, what we are now witnessing is a broad-based investment boom. The lower capital gains and dividends taxes have been capitalized into higher stock values, and that in part explains why the Dow is up 24% since May 2003 while the Nasdaq has risen 39%. Dan Clifton of the American Shareholder Association estimates that this rise in stock values has translated into roughly $3 trillion in added wealth holdings of American households. The severe slump in business capital spending in 2001 and 2002 has now taken the shape of a U-turn, with spending on capital purchases up an enormous 22% since 2003. Because higher wages and new job creation are highly dependent on business capital investment, the mislabeled "Bush tax cut for the rich" has in reality enormously benefited middle-income workers.

All of this brings us to the crucial policy issue of whether Congress will observe these new economic and revenue data and have the common sense to keep a good thing going by making the Bush tax cuts permanent. Thanks to inane budget rules in Congress the capital gains and dividend tax cuts are currently set to expire in 2008. (When was the last time a spending program in Washington expired?) One thing would seem certain: Raising the tax rates on capital gains and dividends would be a formula for choking off the expansion and reversing the stock market climb. Until now, the Democrats in Congress have in unison sanctimoniously charged that the government can't afford the price tag of making the tax cut permanent. But, of course, all this new fiscal evidence points to precisely the opposite conclusion: that we can't afford not to make the tax cuts permanent.

Whether Mr. Bush's critics' ideological blinders make them capable of being persuaded by facts and evidence is an altogether different issue.

Mr. Moore is a member of The Wall Street Journal's editorial board and author of "Bullish on Bush: How the Ownership Society Will Make America Richer (Madison Books, 2004).

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