The Entrepreneurial View #470                                                                      

The Bush Tax Story

by Raymond J. Keating

In his last budget proposal presented early this week, President George W. Bush stuck with the fiscal formula followed throughout his two terms in the White House. That is, a sound approach on taxes, but a lack of restraint on spending.

On the spending side, total federal outlays would rise by 6 percent in fiscal year 2009 (which starts in October 2008) under the Bush plan, which comes in at three times the assumed rate of inflation. Throughout the eight Bush budget years (including this budget proposal), average annual spending increases will have run at better than two-and-a-half times the rate of inflation.

But on the tax side of the equation, there have been many positives. 

The 2001 tax cut package lacked potency because it resorted to tax rebates that accomplish nothing in terms of boosting incentives for working, saving, investing and entrepreneurship, which drive the economy forward, while positive aspects were phased in over too long of a period. It was not surprising, therefore, that the economic recovery coming out of the 2001 recession was very sluggish.

But the 2003 tax cut package had a clear positive impact. It immediately reduced personal income tax rates (bringing the top rate down from the pre-Bush level of 39.6% to 35%), while the individual capital gains tax rate dropped from 20% to 15%, and the top tax rate on dividends also declined to 15%. In addition, the expensing level for small business capital investment increased from $25,000 to $100,000 -- being bumped up to $125,000 in 2007, with levels indexed for inflation.

For good measure, under the 2001 measure, the death tax was placed on a phase out track, with its termination scheduled for 2010.

These tax relief measures were solidly pro-growth.  They enhanced incentives that are critical to economic growth.  And in fact, it is no mere coincidence that economic growth and private sector investment accelerated starting in mid-2003.

However, even the 2003 tax cut had a basic flaw. It's temporary. That is, it has an expiration date. In 2011, under current law, personal income, capital gains and dividend tax rates are set to increase - with the top personal income and dividend tax rates jumping to 39.6% and the top capital gains tax rising to 20%. Small business expensing levels would retreat to $25,000, and the death tax would be resurrected with a top rate of 60%.

It might sound rather distant, but 2011 is less than three years off. The threat of a major tax increase such as this creates fear and uncertainty in business and in the economy in general.  Add into the mix the November 2008 presidential and congressional elections, and fear and uncertainty only mount.  Will the next president and Congress simply allow this looming tax increase to take effect, thereby dealing a heavy blow to the economy?  Will they let some of the tax increases to become reality, but not others?  Or will they extend or even make permanent parts or all of the 2001/2003 measures?

No one knows the answers to these questions, and that is a negative for entrepreneurs, businesses, investors, and consumers.  A massive tax increase looms on the not-too-distant economic horizon like a dark, threatening storm.

The best case scenario would be for Congress this year to follow what President Bush has laid out in his 2009 budget plan. That is, avoid an economy-battering tax hike by making permanent the key 2001/2003 tax cuts regarding personal income, capital gains and dividend tax rates, small business expensing and the death tax.  For good measure, the President's budget calls for further boosting the small business expensing level to $200,000 (again, indexed for inflation going forward), as well as permanently extending the research and experimentation tax credit, repealing the excise tax on local telephone service, and extending alternative minimum tax relief for another year.

All of these steps would be plusses for small businesses, entrepreneurs and investors, and therefore, for economic growth and job creation.

Unfortunately, Congress does not seem all that interested in making pro-growth tax relief permanent. Instead, the focus right now is on a so-called "economic stimulus" package that features demand-side tax rebates, and temporary, targeted business tax measures. This will not help the economy.

In reality, in order to make a real economic difference, tax relief must enhance incentives on the supply side of the economy, and be broad based and permanent. The exact opposite of what's being pushed now under the "stimulus" banner.

Policymakers need to put aside frivolous stimulus talk, and get down to the substantive business of reining in the size of government while expanding pro-growth tax relief. The Bush budget plan has half the equation right.

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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.