Still waiting for the tax-cut boost

The US economy has nearly stalled four years after several major tax breaks took effect.

Economist Paul Kasriel is still twiddling his thumbs, waiting for the predicted good results in the economy from the major tax cuts of 2001 and 2003.

In an analysis a month ago for his bank, Northern Trust Co. in Chicago, he referred to the famous Samuel Beckett play, "Waiting for Godot," in which Godot never shows up.

Last week, Mr. Kasriel said he still can't detect the promised big boost in national output, investment, and savings from what economists call "supply side" tax cuts made by a GOP-led Congress and approved by President Bush.

"The data don't seem to support the hypothesis," he said in an interview.

Kasriel will be watching Friday's gross domestic product (GDP) report to see if the nation's output of goods and services in the first quarter is revised upward. In May, the Commerce Department reported that GDP rose at an annual rate of 0.6 percent after inflation, the worst three-month showing in more than four years.

With a recession under way at the start of this decade, the Republican leadership cut taxes in an attempt to get the economy moving ahead. The cuts were structured to lower marginal tax rates (the rate on the last dollars earned) on wage and salary income, and especially the tax rates on capital income, including capital gains and dividends.

"I don't think you could have ever seen a more scripted supply-side tax cut than under the Bush administration," says Kasriel.

Maybe, he adds, the economy would have performed worse if taxes hadn't been cut. But so far, GDP growth in the current economic recovery has been the slowest of any expansion since 1961. It is even slightly slower than the record-long expansion that began in 1991, during which presidents George H.W. Bush and Bill Clinton raised taxes.

President George W. Bush said in November, "The main reason for our growing economy is that we cut taxes and left more money in the hands of families and workers and small business owners." Kasriel says many factors affect the economy, not just taxes, and other promised benefits of the cuts are hard to find.

He notes that the ratio of business investment to household-related investment (one statistical test of tax cuts' effectiveness), shows a mediocre performance in the current expansion. But when President Kennedy implemented a tax credit for business capital equipment during the economic expansion starting in 1961, business investment did boom.

Jared Bernstein, an economist with the liberal Economic Policy Institute in Washington, says that job growth, wages and income, and the labor supply (the proportion of the population that's working or seeking work) have done poorly in this recovery compared with other post-World War II recoveries from recession.

"The evidence is quite clear – the tax cuts didn't work," he says.

As for the theory that supply-side tax cuts boost private savings, Kasriel comments, "Sadly, this appears to be another case of ugly facts discrediting a beautiful theory." The saving rate has plummeted since 1984 after the supply-side tax cuts of President Reagan.

Another supply-side theory, now less popular, was voiced by Bush in February 2006: "You cut taxes, and the tax revenues increase."

The theory is that with lower marginal tax rates, people work harder and longer, thereby raising their income – and paying more taxes on it.

But even top Bush economic advisers now reject that thesis.

"I certainly would not claim that tax cuts pay for themselves," Edward Lazear, the current chair of the Council of Economic Advisers, has stated.

Economics, though, is not an exact science. There is room for debate. J.D. Foster, an economist at the conservative Heritage Foundation, notes that because the recession at the start of the decade was shallow, the recovery would also be modest. And, he notes, the most important supply-side tax cuts on capital gains and dividends didn't go into effect until 2003. These take time to work.

Chris Edwards, an economist at the libertarian Cato Institute, figures the tax cuts on dividends and capital gains have encouraged investors to create a bull stock market – a big rise in stock prices.

Yes, comments Mr. Bernstein, these tax cuts did redistribute income to the "investor class – those at the top of the income scale."