The investment tax cuts adopted in 2003 worked spectacularly, creating the current economic boom. Indeed, those tax cuts were so successful they resulted in no net loss of revenue due to the resulting economic growth.
But investors will suffer a massive increase in taxes unless the 2003 provisions are extended past their current expiration dates. That will send the economy back into a tailspin, with rising unemployment, lower wages, and reduced economic growth.
The great majority of congressional Republicans support extending the 2003 tax provisions to at least 2010. But the extension is currently opposed by virtually all Democrats and a few Republican liberals, such as Sen. Olympia Snowe (R., Me.). From her position on the Senate Finance Committee, Snowe blocked the extension in the Senate version of this year’s tax bill now going to conference. But the extension can still come out of conference.
A little recent history shines a light on why the extensions are so important.
When George W. Bush came into office in 2001, the economy was already in decline. Then we were hit by 9/11 and a spate of corporate scandals that undermined investor confidence. Business investment declined by a real 7.9 percent in 2001 and an additional 2.4 percent in 2002. The economy fell into recession as a result, beginning in March, 2001.
The 2001 Bush tax cut was well timed to revive the economy. But its provisions were set to phase in slowly, and were not sufficiently focused on pro-growth incentives. As a result, the economy remained sluggish, with weak economic growth. The investment tax cuts of 2003, however, sent the economy into overdrive. That package reduced the tax rates on dividends and capital gains to 15 percent, provided immediate capital expensing for small businesses, and accelerated the tax-rate cuts adopted in 2001 to take effect immediately.
With that tax relief in place, investment jumped by a real 4.4 percent in 2003 and a spectacular 13.2 percent in 2004. Economic growth, meanwhile, has surged to a real average of over 4 percent for the last ten quarters.
The stock market has also roared back to life, creating more than $3 trillion in shareholder wealth. Unemployment has dropped sharply from 6 percent in 2003 to 5 percent today, with the economy creating more than 4.4 million new jobs and the number of payroll jobs setting new record highs on a monthly basis.
Most surprisingly of all, the 2003 tax cuts resulted in no net loss of revenue. In February, 2003, before the tax cuts were adopted, the Office of Management and Budget projected federal revenues for fiscal 2005 of $2.135 trillion. The U.S. Treasury recently closed the books on fiscal 2005, and the final revenue tally was $2.145 trillion, $10 billion more than the revenues projected for 2005 before the 2003 tax cuts.
With the 2003 tax cuts spectacularly stimulating an economic boom while losing no net revenue, there is no intellectually defensible basis for opposing their extension. Without that extension, the tax rate on capital gains will increase by 33 percent, the tax rate on dividends will increase by 133 percent, the top marginal income-tax rate will increase by over 13 percent, and small businesses will suffer still another tax hike.
Such massive tax increases will start to spin the economy downward next year as businesses and entrepreneurs make future investment plans. Ultimately, the economy may be thrown back into recession.
Republican liberals like Olympia Snowe seem to think their constituents are backwoods yahoos who can’t understand these economic realities. But voters will understand a recession and rising unemployment. If the Republican liberals don’t wake up and support the extension, their own reelection chances will be hurt next year, and they will threaten to bring down the Republican congressional majorities.
And if congressional Democrats don’t leave behind the childish, Marxian contretemps of the 19th century, and recognize that the prosperity of working people depends on robust free-market capitalism, they will eventually be consigned to that dustbin of history that Reagan first talked about.
–Peter Ferrara is a senior fellow with the Free Enterprise Fund and director of entitlement and budget policy reforms at the Institute for Policy Innovation.