- The Washington Times - Tuesday, October 5, 2004

This is the 10th anniversary of the “Contract with America.” While much of the discussion has centered on the Contract’s political ramifications, we should not forget it took a revolutionary approach to taxes and economic growth.

At the core of the Contract were five pro-growth tax proposals, three of which have become law. They were first proposed in 1991 by the National Center for Policy Analysis (NCPA) and the U.S. Chamber of Commerce when the United States was in the middle of a recession and policymakers were desperately looking for a way out.

The proposal included a capital-gains tax cut, a new individual retirement account (later known as a Roth IRA), a repeal of the Social Security earnings penalty and a repeal of the Social Security benefits tax and depreciation indexing. The NCPA/Chamber proposal became the basis for a DeLay-Wallop bill, a Gramm-Gingrich bill and several other proposals in Congress. Eventually the package became the economic core of the “Contract with America.”

In the early 1990s, business investment was in a slump and the market bearish. A substantial capital-gains cut promised to increase the underlying value of every stock share of all American companies. A higher return on capital would induce more investment. Capital formation and business creation mean more jobs, higher incomes and increased prosperity.

Once Congress reduced the capital gains rate from 28 to 20 percent, revenues exploded. Over the three years immediately following the reduction, the government collected 74 percent more revenue, though the rate was reduced by almost a third.

Probably the most revolutionary measure was the creation of the Roth IRA. Conventional IRAs allow people to defer taxes until retirement when, theoretically, they face lower tax rates. But because of the 1983 Social Security benefits tax (discussed below), many will actually face higher tax rates once they retire. The Roth IRA permits after-tax contributions that can be withdrawn tax free. Thus, people pay the taxes when their tax rate is lowest.

The third success was eliminating the Social Security earnings penalty, a relic from Great Depression-era thinking designed to get older workers out of the labor force to make room for younger workers. While people between 65 and 70 could earn millions of dollars from investments and still draw full Social Security benefits, the government took away $1 of Social Security benefits for every $3 seniors earned in wages.

There is still work to do. A place to start would be eliminating the Social Security benefits tax. Although nominally a tax on benefits, it is actually a tax on other income, including pensions and 401(k) withdrawals. It causes some seniors to face the highest marginal tax rates in the nation. The House has already passed the repeal once, but it died in the Senate. It’s time to take this up again.

The final pro-growth proposal was depreciation indexing. Our income tax system discriminates against long-term investments. Instead of being able to deduct the full cost of an investment in the year made, firms are forced to spread the tax deduction over a number of years. Yet these rules ignore the effects of inflation and the time value of money. In this way, tax policy makes short-lived assets more attractive than long-lived assets.

President Bush has proposed different ways of achieving some of the same results. For example, he proposes giving everyone access to the Roth method of savings, and increasing the limits. This would shield significant income from the Social Security benefits tax. And proposals for tax simplification, whether in the form of a sales tax, a flat tax or a value-added tax, would eliminate the discriminatory treatment of investment income.

Ten years after the Contract, with the economy slowly recovering from the 2000 recession, it is time to rededicate ourselves to aggressive pro-growth policies.

John C. Goodman is the president of the National Center for Policy Analysis (NCPA).

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