Make the '03 Tax Cuts Permanent, But Curb the Enthusiasm

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The stock markets have shown some strength in recent weeks as word has come out that some Democrats in the Senate aren't eager to see the 2003 tax cuts (including those enjoyed by top earners) expire. This shift in Washington signals increased rationality within the political party possessing the power to make the cuts permanent, plus markets are perhaps also cheered by this development signaling an end to the Obama legislative plan.

Here's hoping Congress does in fact make the '03 reductions law, but if so, investors and citizens more broadly would be wise to curb their enthusiasm. In no way would permanency be a sign that the U.S. economy is set to roar.

About low rates of taxation, it can't be stressed enough that they're an essential ingredient to economic growth. Taxes at their core are a price placed on productive work and investment, and when they're nominally low individuals and investors have a greater incentive to offer up labor and capital to economy-enhancing concepts.

Considering taxes on the rich, when politicians seek to increase them what they're really doing is reducing the wages of the non-rich. All companies and all jobs are the certain result of individuals delaying consumption in favor of saving and investment, and with the rich by definition possessing the most wealth, to confiscate their earnings is to once again decrease the opportunities and pay of those who would someday like to be rich.

Low rates of taxation also serve as the great economic leveler in countries that keep them low. This is hard to imagine considering the media-driven consensus that nosebleed rates on the wealthy reduce the wealth gap.

But in truth, high taxation on those with lots of wealth to tax limits the ability of small businesses to acquire the capital necessary to grow, and compete with the existing commercial giants. Democrats quite simply disagree, and Republicans don't understand that high levels of taxation on the rich serve as a privilege to the successful businesses of today who necessarily face less competition from the successful businesses of tomorrow thanks to capital formation being reduced by excessive taxation.

In short, if the desire among the political class is to aid the poor and middle class in their efforts to knock the rich and established off of their perches, then severely low taxes on the rich should be the goal. Not only should the lower tax rates from 2003 on the wealthy be made permanent, but they should be substantially reduced with frequent churn among the Forbes 400 the near and distant object.

All that said, as the Bush years amply prove, reduced taxation is not the magical elixir that washes away other economic mistakes. Indeed, from the spring of 2003 when the tax cuts were passed to the present, the S&P 500 is only up 34%. During Bush's presidency the S&P was actually in negative territory, and considering the dollar's collapse on his watch, nominal S&P losses don't properly explain how poorly investors did during his two terms.

It's then important to compare the Bush years where tax rates declined, to the 1950s. During that decade the top tax rate was 90%, yet the S&P rose 253%. More modernly, during the Clinton years the top rate on the highest earners was 39%, yet the S&P rose 208% on Clinton's watch. The dollar had a stable definition in terms of gold during the ‘50s, and was mostly strong and stable during the Clinton years.

All of this is a long way of saying that absent better dollar policy, or specifically a commitment on the part of the Geithner Treasury in favor of a stronger dollar, neither the economy nor stocks will rebound in any long-term way. They won't because a weak dollar works at cross purposes with tax cuts given that a weak dollar is anti-investment, and as such, anti job creation.

When the dollar is weak, those with funds to invest necessarily go on strike. Unwilling to see their disposable income be eviscerated by dollar policy that tilts toward debasement, they reorient their capital to the hard and tangible assets (think housing, gold, art and stamps) least vulnerable to currency declines.

To put it more simply, much as nosebleed tax rates on the wealthy redistribute wealth from the productive to the indolent, inflationary dollar policy redistributes wealth away from the savers and innovators, and into the unproductive sinks of wealth most likely to weather inflationary downturns. Currency devaluation is always and everywhere anti-economic growth -- and terrible for stocks -- because savers and investors have no reason to do either thanks to currency debasement eroding their returns.

At this point, what should very much concern those with a classical or supply-side bent is that the ‘03 tax cuts will be discredited by an Obama Treasury vying with those of Bush, Carter and Nixon when it comes to ineptitude. So the plan for classical thinkers should be to push for permanency, all the while well-armed with rational explanations when the tax cuts don't work as well as advertized.

Indeed, while only a crazy person or a congenital socialist would be in favor of allowing the 2003 tax cuts to sunset, those who believe in low rates of taxation should most definitely curb their enthusiasm. As the Bush years once again prove, tax cuts don't work very well when inflationary dollar policy erodes their worth.

 

John Tamny is editor of RealClearMarkets, Political Economy editor at Forbes, a Senior Fellow in Economics at Reason Foundation, and a senior economic adviser to Toreador Research and Trading (www.trtadvisors.com). He's the author of Who Needs the Fed?: What Taylor Swift, Uber and Robots Tell Us About Money, Credit, and Why We Should Abolish America's Central Bank (Encounter Books, 2016), along with Popular Economics: What the Rolling Stones, Downton Abbey, and LeBron James Can Teach You About Economics (Regnery, 2015). 

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